Peter Elston joined Aberdeen in 2008 and is based in Singapore. As Asia strategist, he is responsible for articulating macroeconomic research and the Asian team's investment strategy. He began his career as a fund manager at Merrill Lynch Investment Managers, where he spent 11 years, mostly in Asia.
He shares with AsianInvestor Aberdeen's views about Asian equities.
Looking at a one-year period or beyond, what is your outlook for Asian equities?
Elston: It is very hard to predict how equities will perform over the next 12 months, particularly following such a strong rally. We are still in a period of economic turbulence, in which conditions in the short to medium term may either improve or deteriorate unpredictably. That said, we are now able to envisage, at least conceptually, a world in which Asian economies are able to grow again even if those in the developed world continue to struggle. While the collapse in Western demand for Asia's exports has left a big hole in the region's economies, balance sheets at government, corporate and personal levels are generally in good shape and thus constitute a solid base on which new growth can be built.
What are the biggest opportunities that you see in the coming 12 months?
Our greatest opportunity is also our greatest challenge, namely for our business to emerge from this crisis stronger, relative to our competition. We think broadly that there has been a failure by the investment industry to deliver on its promises. In extreme cases, there is the Madoff fraud or losses relating to certain money market funds and guaranteed products. More generally, many funds promising positive returns in all market conditions have failed to achieve their objective recently. There is also a whole universe of structured products whose risks, and costs, were not fully understood by investors.
What we have always promised our investors is, through thorough, in-house research, to find strong, well-managed companies with the aim of owning them for a long time. The simple principle behind this approach is that it should, over periods of five to 10 years, produce returns in excess of both risk-free rates, as well as market averages. Indeed, we have delivered on this promise in Asia. But the last 24 months have shaken investors' confidence in a buy-and-hold approach to a degree, and our challenge is to try to restore this lost confidence, to remind our audience that investing is about buying great companies, and aligning one's investment time horizon with theirs.
The fact is that we have just witnessed a once-in-a-century event in terms of market performance, and while we may still be in a bear market, now is not the time to run away from a buy-and-hold approach but to embrace it. Indeed, market falls over the last two years have served to highlight the strength of our approach relative to our peers. However, paradoxically, the best time to invest is often the most challenging time to market a research-driven, buy-and-hold approach. But following this crisis the world of the future will be very different to that of the last 30 years, and there will be an abundance of interesting long-term investment opportunities, particularly in Asia.
Has the global financial crisis and its impact played out the way you thought it would?
There are very few who can honestly say that the global financial crisis has played out the way they thought it would. Indeed, we are not among them. For us, what we came to appreciate as the crisis unfolded was the extent to which revenues of companies around the world had, directly or indirectly, been driven by credit-fuelled consumption for a very long time. The high economic growth the world had experienced since the early-80s was therefore clearly unsustainable, and the crisis has been the period in which the world moves, painfully, to a new growth model. Although it is not yet clear what this model will look like, it will almost certainly be one in which bank credit plays a lesser role.
How has your view of Asian equities changed, if at all, since the end of 2008 when investor sentiment was generally gloomier?
Although we had no idea at the end of 2008 where Asian equities were headed, we had started to see a lot of value emerging in our portfolios. Asian equities had reached around 1.3 times book value, cheap both in absolute terms and relative to its historical range.
How has the swine flu affected your investments, if at all?
During the days when fears over swine flu were surfacing, holdings such as Singapore Airlines and Café de Coral underperformed a little. However, since it now appears that the illness may not be as serious as first thought, these stocks have recovered.
Do you expect the swine flu to have a significant impact on investor sentiment in the coming 12 months?
The symptoms of the H1N1 virus are similar to those of what is called seasonal flu, we would not expect investor sentiment to be significantly impacted. That is not to say that a global pandemic will not impact growth nor put a strain on public health resources, but if investors believe that the problem is essentially a temporary one, markets, which price in not just earnings in the near term but all future earnings, should see limited impact.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months -- whether because of the crisis, the swine flu, or other reasons?
We do not operate an active asset allocation strategy. Our country and sector weights result passively from our bottom-up stock picks, though we do check that we do not end up taking excessive risk in a particular country or industry.
Our process is one that favours steady companies with sound financials, and so our portfolios entered the crisis in good shape relative to a market portfolio that included highly geared companies. Although we have always run focused portfolios believing, like Buffett, that diversification is for those who don't know what they're doing, we have further reduced the number of holdings in our regional model over the last year or so to 45 from more than 50. Stocks that have been removed from the model are those which, for a variety of reasons, we felt may not weather the crisis well. We are confident that the vast majority of our holdings are companies which will emerge from the crisis stronger relative to their rivals.
What are your favoured markets in Asia?
We prefer markets, such as Singapore and Hong Kong, where there is a decent level of investor protection in place. If the PCCW fiasco, for example, had happened in a less developed country in Asia, the privatisation may well not have been overturned by the courts. We were not holders of PCCW but were comforted by the SFC's strong opposition to the deal.
What markets are you bearish over?
For the same reasons as with our preferred markets, we tend to avoid or underweight those where investor protection or corporate governance standards are weak. We therefore find it very hard to feel comfortable investing our clients' money in Korea, China and Taiwan. There are exceptions, of course, and these are where we find the investment opportunities, but they remain limited. The Chinese banks are a good example of an industry which is not being run for the benefit of minority shareholders but for the benefit of its majority shareholder, the state. State-directed lending on the scale we are seeing at the moment may boost profits in the medium term, but we would be very cautious about non-performing loans a few years from now.
What are your market weightings within an Asia ex-Japan equities portfolio?
Our model portfolio weightings as of May were:
- Australia 7.2%
- China 6.5%
- Hong Kong 21.2%
- India 15.1%
- Indonesia 1.8%
- Korea 6.6%
- Malaysia 5.2%
- New Zealand 0%
- Pakistan 0%
- Philippines 2.5%
- Singapore 21.3%
- Sri Lanka 0.0%
- Taiwan 5.3%
- Thailand 4.4%
- Vietnam 0%
- Cash 2.9%
- Total 100%
Many fund managers are very bullish on China, citing reasons that include its Rmb4 trillion stimulus package. Do you believe this hugely positive outlook on China shares is well-deserved?
It is very hard not to be bullish about the Chinese economy in the long run, but this does not mean one should necessarily be bullish on Chinese shares. From 1993 to 2002, the economy averaged real growth of nearly 10%, but the MSCI China Index fell by 86% in US dollar terms over that time. Clearly there were huge structural changes taking place within the economy that were not conducive for equities, changes that China will never have to go through again, but it is a reminder that in the case of emerging markets, strong economic growth does not necessarily mean strong stock market performance.
How do you seek exposure to Chinese companies?
We invest in Chinese companies that are listed in Hong Kong or New York. We do not invest in B-shares as the markets there are now very much playing second fiddle to A-shares and to Hong Kong, and anyway do not offer a broad range of opportunities. As for the A-share markets, we have applied for a QFII facility, but since A-shares generally trade at a large premium to H-shares, we do not feel we are missing out on an opportunity. The QFII facility would be of much more benefit to our fixed income team than to our equities team.
Which sectors do you expect to outperform in the next 12 months?
We think that demand from the West for Asia's exports will be stagnant for perhaps a number of years, as consumers in developed countries in Europe and the US rebuild savings. So, broadly speaking, we prefer companies in domestic-related sectors. But this does not mean that companies that are perceived as exporters cannot find new markets within Asia. TSMC and Samsung Electronics are examples of so-called exporters that will see huge increases in demand for their products from within Asia in the next few years and beyond. A company like Li & Fung, on the other hand, is one that might struggle to replace lost Western business with new local markets. Why, for instance, would Chinese department stores need help sourcing Chinese products?
Which sectors do you expect to underperform?
We do not have particularly strong views on which sectors will underperform in the next 12 months. Our biggest underweight relative to the MSCI regional index is in the materials sector, and relates mainly to not holding BHP Billiton or Posco, which together account for more than 5% of the index. Broadly speaking, the materials sector is one where there is no brand value, a factor that can produce sustainable excess returns on capital. While there may be periods of up to three years when the materials sector is reaping good profits and the shares of companies are performing well, we think that it is an industry in which competition soon neutralises excess profit and so one that does not tend to offer good long-term investment opportunities.
Could you please name three stocks that are among your top holdings, and briefly explain why you like those particular stocks?
QBE, China Mobile and OCBC. In aggregate these account for 11% of our model portfolio. They are also stocks we have held for a number of years and thus know very well. QBE is Australia's largest international general insurance and reinsurance group, with an exceptional record of acquiring businesses and extracting higher margins through tight cost control. We have always admired the company's risk discipline and conservative management. Even in high catastrophe years, it has remained profitable. China Mobile is the mainland's mobile telecoms titan, with more than 300 million subscribers, representing 80% of total. The company has consistently grown its customer base while maintaining margins, despite increased competition. Although commercially-run, the only question mark remains over its majority state ownership. OCBC is one of Singapore's three home-grown banks, and over the years has become a strong regional player. Since the early 90s it has grown its book value per share at a steady rate of just over 9% per annum. It has achieved this by sticking to a simple originate-to-hold lending model, one that in combination with steady regional growth can produce excess returns on capital.
What are your investment criteria? Has your criteria changed since the onset of the global financial crisis?
Our investment criteria are the same now as they were 20 years ago, namely proven management teams that have demonstrated a commitment to care for minority shareholders; businesses that are sensibly financed and which present an identifiable, sustainable competitive advantage; and reasonably valued share prices.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
The important risk for our clients is the risk of permanent loss of capital so market volatility over the next two to three years does not concern us. Risks that would result in permanent loss of capital relate to company specific situations such as the accounting fraud at Satyam, derivatives losses at CITIC Pacific, or Gome Electrical Appliance's chairman being investigated for economic crimes. Aside from our process, which has a good track record of weeding out badly-managed companies, the best way to control other company specific risks is through having an optimal level of concentration, in which one is not overly exposed to a particular company.