Planners and investors appear to have short memories. Ten years ago the stellar run of the Asian tiger economies came to a shuddering halt. Until 1997, Asia attracted almost half of total capital inflow to developing countries, with the maintenance of high interest rates by South-East Asian countries proving attractive to foreign investors looking for a high rate of return. The result of these tempting investment opportunities was a large inflow of hot money that resulted in a dramatic run-up in asset prices throughout the region.
This began to unravel in July 1997 when a number of corporate failures resulted in a wave of currency, stock market and other asset price corrections that reverberated around the globe. A decade later and Asia is once again the focal point for investors. While domestic equities continue to pump out high returns, research from Investment Trends indicates financial planners and investors are looking overseas to add something extra to their portfolios. Asked what asset class they thought would be the best performer in the next
12 months, 29 per cent of financial planners said emerging market equities, followed by Asian equities (27 per cent), US shares (17 per cent) and Australian shares (14 per cent). When financial planners were asked what international markets were currently being considered for use for the first time, Asia was the standout at 25 per cent, followed by emerging markets and funds covering multiple regions (19 per cent), Japan (17 per cent) and North America (14 per cent).
Emerging markets
While many international funds concentrate on the more mature, western, developed economies, including the United States, Europe and Japan, some managers are looking to offer more exotic emerging market options. The most common market index used by fund managers as a benchmark for investing in this area is the MSCI Emerging Markets Index, which comprises stocks from 25 countries.
Morningstar research shows there are 17 retail and wholesale diversified emerging markets funds for Australian investors to choose from, together with a number of single-country funds that provide exposure to companies listed in or trading with China and India. There are also 10 superannuation funds and 10 allocated pensions offered by the same fund managers and run using the same approaches to investing.
A lesson learnt
Aberdeen associate director Stuart James says lessons have been learnt from the chaos on Asian markets in the late 1990s and have helped make Asian emerging markets a far more attractive place to invest. "1998 was certainly very difficult and we learnt a lot going through that market, so having been through that you realise you learn more when things are tough rather than when they are going well," James says. Asian economies are now running current account surpluses and are lenders to the market, where previously they were seen as borrowers, he says. They are in the main are much stronger, with large foreign exchange reserves coupled with current account surpluses resulting in a far more robust story. "They are in a far stronger position to weather a global economic slowdown," James says.
According to the International Monetary Fund, the positive global outlook and generally high commodity prices in recent years continue to provide a supportive backdrop for emerging markets and should allow for continued export-led growth. Macquarie Bank head of economics Richard Gibbs says the factor that has changed this time around is that extremely low interest rates in the US, until about 18 months ago, allowed them to significantly lower debt servicing costs and to restructure that debt. "The contraction of credit spreads has certainly favoured indebted Latin American countries and they have been able to retire some of that debt due to the windfall income that has come as a result of the commodities boom," Gibbs says.
Aberdeen has a substantial 20 per cent holding in Singapore, perhaps not a typical emerging markets story as the South-East Asian republic is effectively a developed market with high corporate governance standards. However, James says more importantly the move is not so much a play on the Singapore economy as having more to do with the regional exposure Singapore companies give the group's portfolio. "More and more Singapore companies are becoming regional players, so Singapore is becoming a bit of a base for banking, biotechnological companies and communications. In fact, Singtel, who own Optus, only gets about 60 per cent of revenue from Singapore itself," he says.
Hunter Hall's focus has been on South Korea. The Hunter Hall Global Ethical Trust is aggressively weighted towards South Korea with roughly 28 per cent invested in the north-east Asian country, compared to around 6 per cent in the United States. "There are stocks in South Korea that represent valuations that we haven't seen in Australia since the very early 1980s," Hunter Hall chief executive David Buckland says. "Because of globalisation you've got companies in these countries that are becoming global leaders."
The big two
Investment bank Goldman Sachs predicts China will become the world's largest economy by 2050 and India will be number three by then. Given those forecasts, it is unsurprising those two countries dominate fund managers' efforts at diversification into overseas equity markets, although many other international equities options are available and an ever-growing number of international property and international bond markets are available to the retail market.
Recent growth in China and India has been at breakneck speed. According to MSCI, since 2001 the Indian market has reported 37.1 per cent a year compound annualised return, against 29.1 per cent for China, 13.6 per cent for Australia, 5.6 per cent for the US and 10.2 per cent for international shares (MSCI World ex-Australia Index) for Australian investors. Gibbs says even if they aren't directly investing in China, financial planners should be aware of the impact Chinese financial and capital markets are having on investments globally. The fund industry in China is now worth RMB1.14 trillion, or about US$148 billion, with growth driven by retail investors continuing to redeploy cash savings.
The trillion-renminbi figure is amazing given that just a year ago assets under management stood at less than half that level, not to mention that half of those assets resided in money market funds. China's growing influence in global pricing, investment outcomes and investment capital flows means it has a greater impact on Australian investors' investment decisions. Pointing to the Shanghai stock market's February retreat and the resultant decline on the Australian market, Gibbs says recent Chinese growth figures could also impact on the local markets. "This is despite the Chinese Government trying to rein in investment and credit growth through interest rate rises," he says.
"We don't believe many of the aggregate numbers that come out of China and I don't believe any credible analyst should, so there is no substitute for walking the streets, breathing in the pollution and looking at the dynamics that are going on. "You need to hear the scuttlebutt and also get to know the key policy makers in emerging markets." He says it is also vital fund managers do not treat China as a big homogeneous market. "Watch out if the manager says their product is based on an index or whatever because it is fraught with danger," he says. "You need to put the research time in to understand these markets, so be very wary of managers that simply fly in, fly out and don't have anybody on the ground." Olympus Funds Management managing director John Pereira says India, with its history of relatively stable government and a well-established stock market, offers other opportunities.
Pereira says the growth potential for Indian companies is exciting as the country's population starts to flex its consumer spending muscle. "The fund has a high weighting in financial services sectors as there is still a comparatively low penetration rate into areas such as mortgages, credit cards and financial planning amongst the Indian population," Pereira says. "It's like a dinosaur waking up. Forecasts are that the wealthy will be around 20 million of the population by 2010 with the middle classes at around 200 million and a sub-class below that of another 200 million. "While three years ago the index may have been a lot lower, India did not have the platform to deal with the growth of the market. There is now a tried and true regulatory framework that can handle a growing economy."
Risk and managing it
Zurich risk specialist David Anderson says risk in these emerging markets must be factored in before an investment decision is made. Re-nationalisation of assets and foreign exchange controls are still potentially very real problems for investors. From the mid-1980s through to the late-1990s countries seemed to come to terms with the fluid nature of the global economy, but there a significant shift has occurred since then, Anderson says. "There has been a pendulum swing and it's most concentrated in South America, where there are events that look like classic expropriation of the like that we haven't seen since the 1960s and 1970s," he says.
"It's on investors' minds more than it has been for a number of years, as there are issues across the globe in countries such as Uzbekistan and throughout Africa." Gibbs and Anderson see the upward spiral in commodity prices as a major factor in government policy decisions that ultimately may affect investors as governments try to take a large slice of the economic pie. "As a result of the commodities boom we are already getting some very negative and perverse policy coming out of some of the South American nations. There are feather dusters that have become roosters," Gibbs says. "There is a predisposition in South America to, if you wish, share the cake before you've baked it, and you've seen the rise of populist leaders in these countries.
"They are sharing the wealth rather than concentrating on continuing to generate it and they pay little regard to the stability of the business, investment and policy environment for sustaining the growth of wealth. This is an age-old problem for investing in Latin America." While holding individual stocks may offer attractive looking returns, the sociopolitical structures can offer a level of risk some investors may not want within their portfolios, he says. "It's difficult to take medium to long-term investment views, because there is just such a level of uncertainty about the level of stability and sustainability of the policy environment," he says. "The message there is one of extreme caution where the markets have to be monitored on a daily basis." However, this is in sharp contrast to another developing region, Eastern Europe, where leaders appear to be focused on developing markets, albeit from a small population and capital base, he says.
"One of the best things about the fall of the Iron Curtain is we have seen a scraping of that outdated inefficient capital stock and it's been replaced by first world, first rate capital stock, which has allowed substantial levels of productivity growth to be generated," he says. "Central Asia is also a very interesting spot and one which is very poorly understood, mostly because most of its recent history is enshrined in that of the Soviet Union." It is now only just being understood that the region has substantial precious metal, base metal and energy resources, he says. However, poor infrastructure and idiosyncratic leadership are still problems for potential investors, he says. "It is a very important to understand the changes that are going on in what is now a very dynamic environment and this will increasingly impact upon the Australian economy," he said. "We have to be able to adapt to this change, to understand it and, importantly, be part of it."
