China and Japan unloved by fund managers

Many investors may think that China and Japan are unattractive at present, but there's a lot of money to be made with a selective approach, says Sandro Antonucci, Geneva-based vice-president of fund selection, marketing products and solutions at Swiss private bank Lombard Odier.

Global equity fund managers seem to be widely underweight China, and a relatively low 20% or so of the 125-odd participants at HSBC's emerging-markets conference in Shanghai last week were Western, reckons an AsianInvestor source.

Investors seem to be showing their concern over the various challenges facing the country, including a potential slowdown in growth, talk of a property-price bubble, the effects of tightening measures, inflation- and labour-market-related pressures, and the case for renminbi appreciation (or depreciation), he notes.

However, China's growth momentum remains significant, says Antonucci, who is currently in Asia for research purposes. Even though public investment is slowing down, private corporate investment remains vigorous, and its share of total investment has been on the rise since the start of 2010, he adds.

As a result, underlying businesses in China continue to do well despite weak share prices; Antonucci says to expect at least 25% growth in earnings per share in the coming months. After all, the market has corrected "massively" since July 2009, he says. Chinese markets, both domestic and abroad, became the worst performing in 2010 to May 31, with the CSI 300 falling 22.4% and the MSCI China down 8.8% in US dollars, as against -5.3% for the MSCI All Country Asia ex-Japan.

But with Chinese domestic equities now trading at 13x P/E, they look attractive. "If you talk to China portfolio managers, they see a lot of opportunities there," says Antonucci. Still, it's probably best to keep exposure relatively small -- as a high-alpha part of the portfolio, he adds.

Likewise, Japan is worth considering, on a selective basis, he says, despite its poor performance in recent years. "As emerging markets have begun to wilt recently, an interesting contrarian case can be made for Japan," says Antonucci, "which has more capacity than other markets to surprise investors positively."

There are reasons to be cautiously optimistic towards a market that seems to be under-owned and undervalued, he notes, if investors bear in mind it is "not a safe market per se". In the week to May 26, for example, Japanese stocks saw strong outflows of $3.4 billion, although year-to-date inflows -- at $28.3 billion -- are higher than the total for 2009 of $17 billion.

From a valuation perspective, Japanese stocks are relatively cheap, particularly given that the corporate sector is in rude health after companies aggressively cut costs to protect their margins, says Antonucci. Moreover, Japanese equities have not yet participated as fully as other markets in the global stock market recovery, he adds.

Moreover, Japan is another proxy for China, as Japanese companies expand their business to China to explore huge consumer markets; the number of wealthy tourists from China is increasing year by year; and cash-rich Chinese companies have started buying Japanese companies.

Antonucci stresses he is not making a positive market call on Japan, merely that there are a lot of opportunities in that market at present.

Lombard Odier's Asian model portfolio remains significantly overweight India and Asean countries and massively underweight Taiwan and Korea, he adds. The portfolio currently comprises the Aberdeen Global Asia Pacific Fund (50% allocation), the Hamon Asian Market Leaders Fund (25%), Manulife China Value Fund (20%) and HSBC GIF Indian Equity Fund (5%).

In India, infrastructure and consumption continue to represent strong growth catalysts for the economy, while the government has outlined measures to reduce the budget deficit further, notes Antonucci. In March, the Indian central bank took the pioneering step for an emerging market by moving to raise interest rates, he adds, and other Asian countries are likely to follow suit this year.

In Korea, while exports continue to flourish on strong demand from China, this could lead to won appreciation and hurt the export recovery, says Antonucci, and in Taiwan, rising property prices may lead to the authorities raising interest rates.