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Buy back into Asia – but don’t follow the herd, say experts

08 February 2015

Asian equities had a strong start to the year, but experts say that a selective approach to this part of the market is essential.

By Gary Jackson,

News Editor, FE Trustnet

Asian and global emerging market equities have had a strong start to 2015 but how should investors treat this asset class, which has fallen out of favour over recent years?

During January IA Asia Pacific Excluding Japan has the third best performing sector in the IA universe following a 5.06 per cent average gain while IA Global Emerging Markets was in fourth after rising 4.76 per cent. In contrast, the developed market focused MSCI World index gained just 1.94 per cent.

While this is obviously a short time frame and the asset class is known for its volatility, some investors have highlighted the area as pocket of relative value after its underperformance to developed world equities over recent years.

Performance of sectors vs index over 3yrs

   
Source: FE Analytics

Krystal Tan, Asian economist at Capital Economics, said: “Emerging Asian equity markets had enjoyed a good January, with gains recorded across the board. There were a few factors at play.”

“The ECB announced a larger-than-expected quantitative easing programme earlier this month and markets have started to push back their expectations of when the US Fed will first hike rates. Lower oil prices should support growth in the region, given that most Asian countries are net oil importers. Finally, Asian central banks in India, Singapore and Pakistan have themselves loosened monetary policy and raised expectations that others may follow.”

The macroeconomic forecasting consultancy also expects Asian equities to “nudge higher” in 2015 and go on to record further gains over the medium term, as they tend to be supported by “decent” economic growth prospects.

Investors have started to return to the region as valuations look compelling when compared with markets such as the US and the UK, which have performed well over the past three years.

In its latest asset allocation outlook, private bank and wealth manager Coutts said: “Emerging market valuations remain cheap compared to developed market counterparts and the economic backdrop for emerging market equities is also improving gradually.”

“We see scope for Asian equities to recover lost ground against the MSCI World as global investors are increasingly drawn to the region.”

However, professional investors are quick to point out that a selective approach is often the best way to approach emerging markets because of the wide spread of conditions found within the asset class.

Josh Crabb, head of Asian equities at Old Mutual Global Investors, said investors have to resist “adopting a herd-like instinct” when it comes to allocating to his asset class and says that flexibility is key for success in Asia.

Crabb highlights China and India as two markets that look attractive as the moment, so long as investors are willing to not “blindly follow the herd” and are open to looking off the beaten track.


As the graph below shows, China has underperformed global equities over three years, although it has managed to outpace them over more recent time frames as investors bet on hopes of increased stimulus and a new programme gave them increased access to the Shanghai market.

Performance of indices over 3yrs



Source: FE Analytics

 
“China’s relative cheapness to other Asian markets reflects investor fears that while the country attempts to rebalance away from growth in fixed asset investment to consumption-led growth, the overall rate of GDP growth remains vulnerable,” he said.

“However, infrastructure investment niches, as highlighted by the government’s pledge to modernise its New Silk Road rail network, also create niche investment themes.”

Crabb says this network, which will link east and west China, is creating opportunities among select capital goods companies, while increased research spending and the rise of advanced manufacturing means that globally competitive companies can be picked up at attractive valuations. Meanwhile Chinese brands that benefit from increased domestic consumption also create investment opportunities.

Matthew Vaight, emerging markets fund manager at M&G Investments, is also confident on China, despite the negative headlines surrounding the country’s economic growth, bad debts and large shadow banking system. He cites many of the factor’s that Crabb finds attractive.

“Against this backdrop we think there are opportunities in China as plenty of companies are priced with a crisis in mind. We believe there will be opportunities arising from the fact that China’s economy is in transition,” the manager said.

“The old model relied on low-cost manufacturing, but China is no longer a cheap place to manufacture as rising wages are eroding its competitiveness. We are excited by the number of companies that are adjusting to this challenge.”

“We see firms moving up the value chain and focusing on high-quality, sophisticated products. Many more firms are investing in research and development and brand recognition. By focusing on innovation and quality, Chinese firms can become globally competitive.”

He gives the example of Greatview Aseptic Packaging, which manufactures bacteria-resistant drinks cartons, as a firm that is attempting to build a global presence with innovative products after achieving success in the local market.

Crabb also tips India, even though it was one of the best performing markets of 2014. The MSCI India index surged 31.64 per cent in 2014 after the election victory of pro-business reformist Narendra Modi bolstered investor sentiment.

Performance of indices in 2014



Source: FE Analytics


However, the manager stresses that careful stock selection is “critical” in maximising returns when it comes to India. Certain parts of the market, he explains, are now unable to adequately compensate investors for risks in holding them after their strong gains.

He singles out the consumer goods sector as one example, saying that well-owned consumer names such as ITC and Hindustan Unilever are sitting on very stretched multiples, but says other areas remain interesting.

“Many of the middle sized companies in India have been hampered by a lack of political connections and access to infrastructure, headwinds which will decline under premier Modi’s leadership. These companies also account for most of those establishing businesses in the ‘new economy’ and the associated growth,” Crabb said.

“India’s infrastructure sector is a sector that has been subjected to decades of underinvestment, and continues to be largely overlooked by investors. As a result, several of the stocks trade below book value. With inflation on a declining trend, those companies with large fixed asset bases, such as power generation companies and steel companies, could also be attractive.”



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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.