Asia and pacific rim funds have generated healthy returns in the past year, powered by the resurgence of Japanese stocks and buoyant conditions in South Korea, Australia and India. And fund managers are generally bullish about the year ahead. But there are risks.
One who is somewhat cautious is Daniel Geber, managing director at New York-based Epoch Investment Partners Inc. and manager of CI Pacific Fund, sponsored by CI Investments Inc. of Toronto.
“There are some secular trends that will benefit Asia tremendously, and those have to do with globalization,” says Geber.
Globalization and the burgeoning middle classes of Asia will be key drivers in the region’s development, he notes. Asia’s growth will support markets, he says, “Although it’s not a simple linear equation of buying the fastest-growing markets and hoping to make money. China has been a weak performer until this year, despite the fact it’s one of the fastest growing markets in Asia.”
Geber’s caution is fuelled by several factors. Sustained high energy prices could stall Asia’s economic engine. In addition, a slowdown in the growth of U.S. consumer spending could have an especially negatively effect on China. “There is also a risk of the U.S. Federal Reserve Board overtightening. If it does, this could have a negative impact on global growth,” says Geber. Moreover, geopolitical tensions in the Middle East could throw a spanner in the works.
“The Iranian government’s desire to acquire nuclear technology could create challenges,” he says.
Finally, Geber notes, the avian flu could be economically disruptive. “Markets bounced back in the wake of SARS, but with bird flu there could be more to the story,” he says. Migratory patterns could cause the disease to spread.
On balance, however, Geber is positive for the long haul: “From a strategic perspective, the virtuous forces overwhelm the risks. Asia will be a solid constructive story. Japan, for instance, is going through a transformational phase. But in the very short term, one has to be cognizant of the risks.”
Utilizing a blend of top-down and bottom-up value styles, Geber has allocated 56% of the fund’s portfolio to Japan. That is underweighted relative to Japan’s weighting in the benchmark MSCI Pacific index. There is also 8% in India, which is not in that index, plus 6% in South Korea, 7% in Australia, 5% in Hong Kong and 5% in China. There are smaller weightings in markets such as Singapore and Taiwan.
Strategically, Geber has been positive on Japan since last summer, when Prime Minister Junichiro Koizumi called an election over the issue of privatizing Japan Post, the world’s largest savings bank. That move marked a turning point that indicated Japan was serious about restructuring its economy. Meanwhile, corporate Japan has continued to improve its operations and balance sheets and has become more shareholder-friendly.
One of the top names in the 100-stock fund is Sumitomo Realty & Development Co. Ltd., which has a portfolio of about 200 office and commercial buildings, mainly in Tokyo, that are relatively new and appeal to tenants who want to upgrade their premises. Acquired in January 2005 at an average cost of 1,400 yen a share, it recently traded at 2,700 yen. Geber’s 12-month target is 3,500 yen.
Another favourite is Osaka Securities Exchange, the second largest exchange in Japan, measured by trading volume, which has capitalized on the return of the retail investor. Bought last fall at 600,000 yen, it was recently slightly more than one million yen. Geber’s 12-month target is 1.3 million yen.
Geber also likes China Shineway Co., one of the largest makers of traditional Chinese medicines; it has facilities comparable to pharmaceutical companies in the West. A Hong Kong-listed company, it recently traded at HK$5.10 a share, although Geber paid HK$3.50 last fall. His 12-month target is HK$8.
Also cautious is Franki Chung, manager of Talvest Asian Fund and CIBC Far East Prosperity Fund and Hong Kong-based head of the Asia-Pacific equity team of CIBC Asset Management Inc. , which sponsors the funds.
“We are less bullish than before, partly because of the valuations,” he says. “Share price performance in Japan was very strong until the end of January. Some of the small-caps and resources were running a little ahead of themselves. The fundamentals are there. But we expected some short-term weakness, which happened in February.”
@page_break@The two funds are virtually the same, except that they are sold through different channels.
Looking ahead three to six months, Chung expects to be more selective. “We are likely to see across-the-board re-rating of stocks,” he says. He will watch earnings results from Chinese and Hong Kong companies, which have December yearends; Japanese firms have March yearends.
“With valuations much higher, there is less room for disappointment,” he says. “Those companies that can provide not necessarily earnings surprises, but guidance skewed to the upper end of the spectrum. That’s what we are watching for. We try to hold on to names that have potential earnings surprises, rather than ‘torpedoes’ that could become earnings downgrades.”
Chung has allocated 63% of the funds’ assets to Japan because he believes earnings growth is underpinned by strong capital spending. There is also 7% in Hong Kong and China, which are lumped together, 7% in South Korea, 5% in Taiwan, 9% in Australia and lesser weightings in Singapore and Malaysia. There is no exposure to India, although Chung is considering that market.
A bottom-up GARP investor, Chung is running a 100-name portfolio. Among the top holdings is Mitsubishi Corp., Japan’s largest trading house, which has world-wide energy, food and metals interests. “It has very strong earnings-per-share growth,” he says. Earnings are expected to jump 80% for fiscal 2006 because of high energy prices. But for fiscal 2007, he expects growth in earnings per share will be in the 7% range. In terms of balance-sheet strength, Mitsubishi’s debt/equity ratio is two, which is lower than its peers. Bought in mid-2004 at 1,137 yen a share, it recently traded at 2,575 yen. Based on the current price/earnings multiple of 12, which is at the lower end of the historical range, he has a floating target. He may trim the holding once it reaches a multiple of 20.
Another favourite is Aluminum Corp. of China. Otherwise known as Chalco, it is the world’s second-largest producer of alumina, which is transformed into aluminum.
“We have a positive view on the commodity price,” says Chung. “Volume is expected to grow by single digits in terms of tonnage. It’s trading at six times earnings, compared to peers that trade at 10-12 times.”
The stock has a 3.5% dividend yield. Acquired through 2004-05 at HK$4-HK$5, it recently traded at HK$8.20. The 12-month target is HK$9.50.
Chung also likes Shinsegae Co. Ltd., a leading South Korean discount department-store chain that is that country’s Wal-Mart. Bought in 2001 at 150,000 won, it was recently trading at 450,000 won. Based on its 20% return on equity and a P/E of 17, Chung expects the stock to rise 10%-15% within a year.
Justin Nightingale, manager of Altamira Asia Pacific Fund, sponsored by Altamira Investment Services Inc. , and assistant vice president at Montreal-based Natcan Investment Management Inc. , is bullish, especially on Japan. “Inflation is creeping back into the system,” he says. (It was 0.1% in January.) “We are also starting to see consumer confidence return to levels not seen since 1991.”
As well, the Bank of Japan is openly talking about lessening its interventionist role and reducing the amount of money it lends to Japanese banks. “These two things could be seen as negative,” he says. “But you have to remember why they are happening. It’s because the picture is getting better.”
Interest rates are still at rock-bottom lows, so Japan is a long way from matching other industrialized countries.
Like Geber, Nightingale points to the privatization of Japan Post. Although it will take 10 years to unfold, it is a key event. Japanese politicians will not be able to use the institution for pork-barreling purposes, as they have for decades. “You will have more rational reasons for making investments and effectively alter the flow of capital in the economy. That’s why the privatization is so important and an example of the types of reforms Japan is implementing,” he says.
The fund is different from its peers in that it is mandated to hold at least 50% of its assets in Japan, 33% in Australia, 10% in Hong Kong and the balance in smaller Pacific Rim markets (Singapore and India are excluded, however). At present, it has 51.2% of its assets in Japan, 35.1% in Australia, 9.5% in Hong Kong and the rest in cash.
Nightingale acknowledges that the Japanese market is likely to take a breather this year after returning 45% in yen terms in 2005: “There is room to grow. But before we get a higher move, we have to see a confirmation of factors, such as increased consumer confidence and spending.”
The 44-name fund has larger positions in Japanese stocks such as Orix Corp., which specializes in small and medium-sized business loans. The firm has benefited from corporate Japan’s turnaround. Bought last September at 20,455 yen, it recently traded at 31,050 yen — 17 times fiscal 2007 earnings.
“In times of economic recovery, SME exposure is a big plus for financial services stocks. SME growth is better and margins are better,” Nightingale says. “Orix also has a really good management team and is good at identifying new market opportunities.” Although he has no stated target for the stock, he likes to take a long-term perspective.
Another top holding is Toyota Tsusho Corp. A part of the Toyota group of companies, it offers logistics and design services to Toyota’s global manufacturing capability. “You get access to Toyota’s production growth outside Japan,” says Nightingale. The firm also benefits from Japanese vehicle export sales to fast-growing markets such as China. Bought last September at 2,060 yen, it recently traded at 2,665 yen. “I am a little underweighted [in] Toyota Motor Corp.,” he says, “but have this one to offset that. I get faster growth in the process.” IE
Globalization expected to boost Asia and Pacific Rim funds
But high energy prices, slow growth in the U.S. market and geopolitical strife elsewhere could be bumps in the road
- By: Michael Ryval
- April 4, 2006 October 30, 2019
- 10:18