Every month, we invite the best investors we know for dinner and ask what they would – and would not – put their money in now.
Here five top investors tell us why Asia is a ‘great story’ in the long term, and give us their favourite stock picks, including an Indonesian natural resources play, a Thai bank – and an easy way to profit from Asian hedge funds…
Annunziata Rees-Mogg: This could easily end up being a China-orientated Roundtable, so perhaps, Stephen, we could start off by discussing the smaller Asian economies.
Stephen Swift: Asia is probably due for a good year in terms of economic growth. I think the encouraging feature is that forecasts are being raised and are higher than they were a few months ago, and they could be raised again later in the year. Japan is an important locomotive of growth for the whole of Asia. It’s recovering, and China, importantly, is showing stable, but rapid growth now. Overall, the global economy is quite strong – led, of course, by the US.
ARM: Tim, would you agree that the outlook is positive?
Tim Price: I would be altogether more simplistic about it. If you split the world into three areas – the Americas, Europe and Asia – I can’t see how anyone, in the long term, isn’t going to vote for Asia. All the fundamentals, for example, economic growth and demographics, are supportive. It’s not necessarily cheap as a trading play, but in the long term it’s a great story.
ARM: Greg, would you agree?
Greg Kuhmert: I broadly agree, but my concern for this year is that there seems to be a degree of complacency. Too many people are talking about the “Goldilocks economy”, and that makes me a little cautious. If US consumer spending were to slow this year – and cracks are appearing in the housing market – then Asian exports would be at risk.
ARM: Ben?
Ben Rudd: We see southeast Asia as the most positive region this year. Last year, a lot of the domestic distortions were removed; fuel subsidies, for example. There’s scope for lower, short-term interest rates in the second half of the year as inflation comes down. This makes a very positive mix for liquidity. The missing element has been economic growth, but domestic leading indicators suggest it should start to recover soon. Earnings growth, too, is on the cusp of an upgrade cycle. Finally, the domestic investment outlook is positive. This year, as governments start to spend money, there’s going to be a more structured driver for domestic and employment growth.
ARM: Could that reduce the reliance on the US consumer?
BR: It can help to broaden the overall domestic demand outlook. Asia is still very cyclical and the employment cycle has been closely tied to the export cycle. The big problem is that we haven’t had a proper domestic or corporate investment cycle, but it’s a matter of degree. If we have a gradual slowdown in the US, we’ll have a bit of a hiccup. But Asian economies should grow. If there is a US recession, it’s going to be a different matter. Northeast Asian markets would be particularly vulnerable to that.
Edward Cartwright: Having just come back from Japan, I think there is a perception that the US interest rate cycle is a lot nearer the end of its cycle than it was six months ago, that the huge amount of money thrown at Asia by American investors is slowing down and that money is being diverted to other markets, for example, in Latin America.
SS: It is easy to talk about economics in Asia. Asia has always been about economic growth, but stockmarket performance is not necessarily a mirror of that economic growth. Visit the region now and it is a different place compared to ten years ago. But the stockmarket is half the level it was a decade ago. It has actually been a lost decade for investors in the Asian region. And while countries are back on track economically, their stockmarkets are still fragile. At the end of the day, investments are about return on equity (ROE), they’re not about GDP. I also think it’s worth emphasising that Asia is diverse.Why was Korea so strong in technology and Taiwan so weak last year – the answer is not foreign, but domestic money. Locals were buyers of their own market in Korea and sellers in Taiwan. It is too easy to assume that it’s global flows that steamroller the region in both directions. But if the locals are against you, you’re not going to make much progress.
EC: But there was a huge dichotomy last year where you had domestic selling and foreign buying, and the foreigners won – which is very different from what you are arguing.
SS: The dream scenario is what you got in India and Korea last year – where the locals and the foreigners both did the same thing. Another point is that local companies often focus more on top line growth than on bottom line growth.
EC: But that is the key change in Japan in the last three years.
SS: It’s still got a long way to go in mainland Asia. That’s why earnings, ROE and so on have been going in a different direction to the actual volume of sales. Ironically, that’s what makes me slightly nervous when you talk about capex (capital expenditure) growth, because that was the curse of Asia in the 1990s – too much cheap money and inefficient capital allocation, and too many hotels and office blocks going up. On the other hand, there is now extra industrial capacity, and since 1997/8 financial disciplines have improved – partly because the banks have been more careful to lend and chastened owners a bit more wary to borrow. I’m not saying capex is bad, but there is the risk that Asia goes back to its old ways.
EC: It also depends very much on how you finance the capex spending.
TP: Is Asia the likely beneficiary of global hot money?
EC: Well, absolutely. And I come back to Stephen’s point about the dislocation between markets and the economy. In Japan, the correlation between the economy and the markets has broken down in the last three to four months.
SS: The problem in non-Japan Asia is that the proportion of hedge funds is very high in relation to total turnover, and the facilities for going short are very limited. The door is very small and the flow is potentially very large.
EC: There are very few subjects I know anything about, but Asian hedge funds are my specialist subject. The rate of change in the development of the hedge fund sector in ex-Japan Asia is enormous. The tools for hedge fund managers are growing and the commoditisation of the hedge fund arena in Asia is staggering – in terms of administration, prime brokerage, private equity investment. All these things didn’t exist in 2001, and now they’re beginning to look very similar to Europe. Stock borrowing is a lot tighter, so selling stock short takes place in a much more crowded space. It definitely exacerbates volatility, but volatility is normally greater in Asia than in the West.
TP: In the short term it probably makes everyone’s life more difficult, but in the long run most hedge funds are inherently not long-term investors.
SS: I would emphasise that we are making generalisations about ten or a dozen very different countries.
EC: It is incredible how many investors in this part of the world do try and put Asia into one bucket.
SS: Investing in southeast Asian companies is a bit like investing in a 19th-century British company – when you went to visit Mr Cadbury or Mr Beecham or Mr Boot. You were talking not only to the manager, but the owner. There are very few genuinely public companies in southeast Asia in the way that you might think of them.
EC: Is there still a lot of family ownership?
SS: Most companies in Asia are family controlled. They don’t necessarily own 50% of the company, and it’s a bit like a family heirloom really – they pass it from one generation to the next. They have the advantage of long termism: they’re not necessarily share price sensitive and they don’t have to worry about issuing stock options to their staff. Unless they want to raise money, and frequently Asian companies prefer to generate capital internally, why do some companies bother having a stockmarket quotation at all? Now that is a traditional approach and things are changing – faster in some countries than in others. One of the features of a family company in Asia is that rather than vertically integrate, they diversify – into land or property – and end up as a conglomerate with a range of different companies.
Some countries have been tightening up. In Korea, banks are being told to concentrate on their core businesses, so they have to sell off their hotel and property interests. Many Chinese businessmen start off poor and illiterate, and then the first thing they do is spend as much as they can on a good education for their children. So the sons go off to Cambridge or Harvard and get MBAs. They come back with Western ideas from working in investment banks for a period of time, and so they are more aware of their companies’ share price. But there are pressures – obviously generational – ownership dilutes as you have more children and grandchildren. So that’s one feature prevalent throughout the region. There’s also pressure from financial markets, but a prime concern is to ensure that you don’t dilute yourself out of control if you raise capital on equity markets.
Finally, the Asian crisis shook people; they became aware of some of the risks they were taking, so we have seen a greater efficiency of capital use in the last five years. This has led to higher ROEs, at least an awareness of profits, and, interestingly, dividend payments have increased. And that’s not always been the case in a region where capital gains are generally tax free, whereas dividends are taxable.
TP: The big question mark I would raise would be over China, which I refuse to believe is even a million miles away from being a capitalist or free market or rule-of-law-based economy.
EC: Yes, but China has experienced big changes in the last three or four years. Three or four years ago, if China had a hard landing it was a regional issue. Nowadays, it’s a global issue.
TP: Maybe China has replaced the US as the hard landing problem for everybody.
EC: I think it is beginning to get close.
SS: One of the things you’ve touched on that is very important as well, is the speed of change. It’s a very visible aspect of the economy. It’s not just all the building activity outside your window. You can see the place moving, literally, in front of your eyes. But what is not so easy to monitor, but is equally fast, is the social and political change taking place throughout the region. It is breathtaking.
EC: But in terms of capital markets and the evolution of capital markets in China, you do sense sometimes that there are many years to go.
TP: Maybe it’s better to buy shares in companies that supply commodities to China?
BR: One of the big problems you have, in terms of profitability in China, is that there is an exceptionally low cost of capital. In a capitalist society, one of the main barriers to entering any industry has to be capital. In China, however, there are huge amounts of capital handed out to locals and, in many cases, it’s never repaid. The borrowers just service the loan interest and, on maturity, they roll it over with the bank. This is a massive misallocation of capital.
BR: It reminds me of Korea in the 1990s, when capital was also misallocated.
GK: The Chinese business model is often about cranking out lots of widgets and without much thought about profits. In China, I think it’s important to look at companies with strategic advantages in their market – either because they’re monopolies or oligopolies, or they have entrenched positions in the market where there are high barriers to entry. Those are the sorts of companies I like in China. There is often too much capacity expansion at the cost of margins and at the cost of shareholder returns. And whenever they run out of money, they come back to the market. China wants to open up the markets to foreigners, but there are so many steps they have to make to get to that point. I think the bigger problem is about persuading more local people to invest in the equity market and take their money out of banks. Institutions could take the lead, which might help improve corporate governance, but that is still some way off. The market is too opaque for them anyway, so there’s a chicken and egg problem.
Coming back to the impact of hedge funds. Sure, hedge funds chase themes, but if you visit companies in the region you get a sense that they also push managements to do the right things and think about ROE and the other things we’re all interested in. I think that the more investors are asking questions and kicking the tyres, the better it will be for the region in the long term.
EC: I think that’s absolutely right. The fact of the matter is that for all the negatives on hedge funds, particularly in emerging Asia, they are providing a role that the merchant banks provided in Asia 50 to 80 years ago.
GK: Good liquidity comes from retail investors; when people put aside regular amounts of money every month, like you see with regular savings schemes in Korea.
ARM: So what are your favourite stock tips?
TP: We are probably agnostic in terms of allocating to China directly because, as I have already conceded, I think that’s a difficult game to play. But indirectly, we invest through diversified commodity companies. So our China plays at the moment would include BHP Billiton (BLT.L), Anglo-American (AAL.L) and Rio Tinto (RIO.L). Overall, India is the preferred play. It is a country where English is widely spoken and there are some very competent technical colleges. There are also such compelling wage arguments in favour of products and services migrating over to this part of the world.
The way we would gain exposure is through buying either actively-managed funds or even exchange traded funds (ETFs) that just give us broad exposure to the whole region.
BR: Asian markets have massively underperformed the rest of the emerging markets universe. And on a very simple basis, if you think about emerging markets, whereas Asia is a commodity user, Latin America is a commodity producer. This has been the trade since 1998: you bought the producer. Also, up until very recently, Asia didn’t really pay market prices for energy and raw materials because Asian governments subsidised domestic consumers. This year, they’ve got used to paying market prices.
EC: So your emerging markets advice is to get a bit of Asian exposure.
BR: Exactly.
ARM: And what do we buy?
GK: I like Taiwanese and Korean technology companies, because I think there are a lot of new products coming out there this year that are going to drive growth. There’s a new games console from Microsoft, for example. LCD televisions will probably replace CRT TVs, and when the price is right they’ll be adopted by the mass market. You’ve got pretty good growth in mobile handsets this year as people migrate to higher megapixel phones, and people are now buying 3G phones. A lot of the earnings growth you’re seeing in Asia is on the back of a revival of technology spending, so I think the valuations look pretty cheap. Of course, what might spoil the party is if you have a slowdown in US consumer spending, because then you can basically call the game over on the technology front. But I think there are structural reasons to believe that technology stocks will outperform this year.
ARM: Any specifics?
GK: I think LG Electronics (066570.HK) stands out. On the handset side, they’ve got a number of models coming out that are actually quite sexy. They’re selling quite well in Korea and are starting to do well in Europe too. I like AU Optronics (2409.TW), which is a Taiwanese LCD panel producer and is moving from making more commoditised LCD panels for laptops and PCs and moving into LCD televisions, where the margins are higher. If we are in an upcycle in the tech sector this year, the margins from some of these technology companies are going to go back up towards peak cycle margins. And the other sector we like is telecommunications, especially China Mobile (0941.HK) and Telekomunikasi Indonesia (TLKM.JK). Indonesia’s penetration levels on the mobile side is very low relative to the more developed parts of Asia and developed countries.
ARM: And Ben, any favourites?
BR: We still like technology as well. But we also favour construction companies. We’ve seen very strong order uptake coming through. We would add to that some of the capital equipment manufacturers in India. Southeast Asia is the market we think is underrated in terms of growth expectations. We also think that domestic liquidity could start coming out of fixed income into local equities, and so we would probably add several of the banks in Thailand. Bank of Ayudhya (BAY.TB) does stand out.
EC: I think equity volatility is going to remain pretty high. So I think a great way to buy Asia on an absolute return basis is a fund that I help manage, and is listed on the London Stock Exchange. It’s called KGR Absolute Return PCC (KGR) and is a fund of Asian hedge funds. It is the only Asian fund of funds.
ARM: Stephen?
SS: I’ll pick an Indonesian stock. It is a country that’s traditionally rich in natural resources and until recently was a major oil exporter. However, it is a very serious and still under-tapped gas supplier. I’d choose Medco (MEDC.JK). As I say, there are a number of opportunities throughout the region and that’s just one I’ve picked.
GK: I think you have to be quite selective this year, and I think valuation is especially important.
SS: Remember that Asian markets produce very different returns. I’m always trying to emphasise the extraordinary diversity and variation between countries.
Our panel
Edward Cartwright, Analyst at KGR Capital
Greg Kuhmert, Fund manager at Investec Asset Management
Tim Price, Senior investment strategist at Ansbacher
Ben Rudd, Regional investment strategist at ABN Amro Asia Securities
Stephen Swift, Director of Jade Absolute Fund Managers