Report: AIC Asia Pacific Excluding Japan

The 3 year average return of the 11 funds with at least 3 years of history stood at 30.5%, underperforming the MSCI Asia Pacific ex Japan index's 44% return by 13.5%. Performance ranged from 49.76% to 11.7%, with only 2 trusts that outperformed the MSCI Index. The sector average annual volatility stood at 18.43%, similar to the 17.04% of the MSCI Index.

This risk factor ranged from 16.76% to 31.38%, with trusts that generally posted higher returns tended to have higher annual volatilities associated with them (see Financial Express Glossary for definition of terms).

The highest Sharpe ratio (which accounts for excess return generated per unit of risk) stood at 0.7, suggesting that no trust was able to outperform the Index in terms of risk-adjusted returns over the last 3 years. Based on past performance, investors seeking better risk-adjusted combinations should look towards the IMA Asia Pacific ex Japan counterpart where 25/79 funds have Sharpe ratios above that of the MSCI Index, or alternatively simply invest in an Index tracker fund to capture the best risk-adjusted returns.

Nonetheless, when addressing the short-term (past year to June 2008), coupled with slowing global markets and increasing volatility, only the independently managed Pacific Alliance Asia Opportunities has shown a gain, posting a return of 15.82%. This trust invests predominantly in Macau & China (78.07%), with a significant weighting towards money markets (19.63%). Furthermore, it also dabbles in pre-IPO investments, share class arbitrage and bridge financing. Although a relatively new trust, it’s more specific focus has given it an impressive Sharpe ratio of 0.67 compared to the MSCI Index's - 0.03 (past year to June 2008), and is an interesting trust to keep an eye on.

Outlook

The sector's average NAV discount has widened from - 6.9% in June 2008 to - 8.7% in July 2008 suggesting worsening market sentiments towards Asia Pacific ex Japan. This is comparable to the -12% average NAV discount for all AIC sectors, which reflects the fears surrounding the unfolding subprime crisis, rising global inflation and slowing global economies.

Most Asia Pacific countries were not directly affected by the subprime debacle and their financial institutions remain relatively stable, however they maybe affected by a global slowdown as a lot of economies like China, India and Vietnam have export based economies that rely on strong consumption of goods in more developed countries like the US and Europe. Fears of slowing exports are further compounded by aggressive annual rises in domestic wages (especially in China and India) and the rising prices of commodities like oil, steel and aluminium, which filter through as higher prices on finished goods with rising prices translating into less sales.

This is part of the reason that emerging markets like China and India have responded splendidly to the recent falls in oil prices this week to below $130 a barrel, because it eases pressure on production/transport costs and at the same time encourages spending in more developed countries. Nonetheless, even with lower oil prices, if that is the case, the world still has the unfolding subprime debacle to deal with following the collapse of Indymac and recent exposure of the instability in Fanny Mae and Freddie Mac.

The fact that a lot of Asia Pacific countries are dependent on exports to the west, the most sensible protection would be to diversify away from this dependency. Diversification in terms of export location has already caught on in Asia Pacific, as the Middle East and Europe take on a higher percentage of total exports in recent years. Similarly, another important factor that will protect Asia Pacific against a western slowdown will be how domestic consumption develops in these countries. If Asia Pacific countries are able to develop sustainable domestic demand to support the production of their own goods, as opposed to depending on western consumption then they should be able to weather most of the storm that is yet to come.

These are the main points that investors should consider before investing in this relatively volatile sector. As it is unclear how much the region’s export orientated economies will be affected by a western slowdown, markets in Asia Pacific may still have much further room to fall. Investors that are looking to invest in Asia Pacific ex Japan should remain cautious and may want to wait to see how things pan out in the short-term. Nonetheless, in the long-term investors should still be able to pick up some bargains in China, India and especially Vietnam, as we have learnt from the past economic crises in Asia, things don’t take long to pick up and when they do most investors should see some handsome returns.

*Source of all data: Financial Express Analytics