South East Asian equity markets have been roiled in recent months by a growing risk-off move from investors, after the US Federal Reserve hinted earlier in the year that it could soon begin to taper off its quantitative easing policy. However, while an overflow of liquidity from central banks in developed markets has contributed to the outperformance of emerging market equities in recent times (drawn in by comparatively stronger GDP growth rates), this should not detract from the structural merits of many of the companies based in the region. If anything, the recent pull-back in valuations in some “hot” markets, such as Thailand, has merely cleared the path for long-term stock-pickers to start buying again. In this perspective, Allan Liu, portfolio manager of FF South East Asia Fund, sets out his current investment strategy and market views.
ALLAN LIU, PORTFOLIO MANAGER OF FF SOUTH EAST ASIA FUND
Q: Is recent volatility being driven by fundamentals?
A: Recent volatility in stock markets has partly been driven by some changes in country and company fundamentals. But the prevailing low interest rate environment of the past two years (as a consequence of QE policies) means that any change in the risk premium has had a much bigger impact on capital values and the flow of funds. So the key thing to stress is that any change in fundamentals has been magnified in recent years by low interest rates and the change in risk premiums.
Q: Is ASEAN experiencing a liquidity crunch?
A: Clearly Asia’s emerging markets have seen some large inflows over the past decade, both debt and equities. We’re now seeing investors move out at the same time – either to take profits or simply to remove risk from the table. Some markets in Asia aren’t developed or mature enough to cope with some of these flows, and for this a certain level of caution has been needed to deal with an overcrowded trade. However, from a pure stock-picking perspective, countries such as Thailand and the Philippines are now off about 20% from their highs, and multiples are looking more reasonable.
Q: Is it getting harder for a growth style of investing to succeed?
A: It has been difficult for a growth style (defined as finding stocks with growth at a reasonable price) to really perform in the last few years in Asia ex-Japan equity markets as the environment has been very unfavourable. This is an unusual situation by historical standards for these markets. This year has been slightly better and there are some good opportunities in China, such as construction and autos, which have performed well in spite of the slower economic growth trajectory in the country. Even though China is moving from an export-led model to a more domestic consumption-focused economy, some companies there can compete because of high-quality management and products.
Q: Which countries are attractive currently?
A: Currently I’m finding more opportunities in Korea and China. In China, we can find quality stocks with good management and growth potential – not necessarily profits growth of 40-50% but companies with 20-25% growth potential and valuations somewhere in the teen multiples. In Korea, the market was hit earlier this year by a weaker yen, but many corporates have strong franchises and are not simply a play on the KRW anymore. And in terms of the competitive threat from Japan – short term currency movements are unlikely to prompt a sustainable swing in competitiveness. Generally, Japanese companies need to invest more heavily in R&D to improve their products and innovation. Consumers will not buy a Japanese handset simply because it’s cheaper
Q: How much of a threat is the recent liquidity squeeze in China to market prospects?
A: The PBOC’s recent action to tighten credit seems to be aimed at smaller banks that have expanded their balance sheets aggressively into wealth management products. The PBOC is trying to rein in smaller banks and curtail credit growth. The short term surge in interbank lending rates in China will hurt smaller banks but it actually helps bigger banks by boosting their margins. Obviously there is a fear of systemic risk but on current evidence, this seems unlikely. China corporates are now expecting more moderate levels of growth. As such, expectations are more realistic and it’s time for managements to perform and for investors to pick those winning companies. There are still growth elements within the economy and generally these companies can be found among the private enterprises. SOEs, in general, tend to be more passive and do better within a high growth environment. The recent sell-off in China is a case of volatility driven by policy actions. This provides an opportunity to switch from performing stocks with rich valuations to stocks that have been sold down but which still have good growth prospects. It will take some time for the PBOC to rein in smaller banks and control credit expansion via wealth management products. In reality, there is no real shortage of liquidity in the system. Unfortunately a large part of this credit has not gone into manufacturing and the productive side of the economy, so there’s a need to rebalance.
Q: Which sectors look favourable currently?
A: Information technology is still an attractive play although many segments are a good example of ‘winner takes all’, such as semiconductors and handsets. Renewable energy is likely to be an attractive theme over the next few years, particularly within China, because of lower coal usage driven by economic, environmental and health reasons. Around 2-3 years ago, investors would have to pay multiples of 30 times for these new energy stocks but now that earnings have started to come through, some of them are trading at teen multiples and the uptake of this kind of energy will only grow going forward.
Q: Where is Asia in the current economic cycle?
A: Asia ex-Japan stocks are in a cyclical slowdown in the near-term but this is generally in line with the global economic picture. However, Asian markets are still growing relatively faster than many other regions and are still providing lots of investment opportunities. There are no major macroeconomic concerns apart from issues in some of the smaller economies. Stocks in general are at fairly low valuation multiples compared to the historical trend. As interest rates normalise over the next 3-4 years, volatility should diminish and then quality and growth should come to the fore again, benefiting bottom-up stock pickers.
is Portfolio Manager of Fidelity Funds – South East Asia Fund. The investment objective of his funds is to achieve long-term capital growth from portfolios made up of the shares of companies throughout Asia Pacific ex Japan. Allan was named the Best Fund Manager, Asia category in the 15th annual Investment Week Fund Manager of the Year Awards in the UK in 2010. He has been a Portfolio Manager since 1990 and began his career at Fidelity as an Investment Analyst in 1987. Allan also worked as Business Analysis Officer at Chase Manhattan Bank between 1986 and 1987. Allan holds an MBA from the Chinese University of Hong Kong as well as Bachelors in Social Sciences from the University of Hong Kong. He is a CFA charter holder.
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