Baring Asset Management (Asia) is busy promoting the growth potential of Southeast Asia as it seeks to spur investment into its Asean Frontiers Fund following a raft of redemptions.

The retail fund has been hit in line with the a sharp shift in investor sentiment away from emerging market equities to developed market equities since late last year amid fears of inflation.

The Baring Asean Frontiers Fund has seen a 29% reduction in assets to $270 million, from $380 million last year.

The fund is at least 70% invested in core Asean equity markets – Singapore, Malaysia, Indonesia, Thailand and the Philippines – with up to 25% set aside for frontier markets and Greater China. It targets unrecognised growth potential and so has a small- to mid-cap bias.

A large proportion of the fund’s investors are based in Hong Kong and Europe, notably Germany, as well as Taiwan, says SooHai Lim, senior investment manager for Asian equities at Barings.

“The main holdback [investors] had when I went marketing this year was that they were worried about inflation,” he tells AsianInvestor. “There has been this emerging market to developed market switch.

“Now people are wondering when to increase exposure to emerging markets and Asia. They have seen how China and India have done, and we believe [Asean] will be the next one to go.”

Core Asean markets can deliver sustainable GDP growth of 5-7%, says Lim, driven by a rapidly expanding labour force – the region boasts a young population of 600 million. It also has GDP per capita of about $3,000 – room to grow without a great deal of capital investment to boost productivity.

He argues that the long-term growth potential of China and India is also positive for Asean since the region boasts both hard and soft commodities. He notes, for example, that Thailand, Indonesia and Vietnam together produce 90% of world rubber, which is used in tyre production.

But Asean equity markets are underdeveloped relative to GDP (see graph, left). The region’s stock market cap is bigger collectively than it is for Australia, Korea and Taiwan, yet its MSCI index weighting is still lower.

The MSCI uses a free-float adjusted methodology to calculate market-cap ratings, which excludes government-held stock. A lot of large-cap companies in Asean markets are still majority owned by government entities.

“But the trend over the last few years has been for governments to divest holdings in order for the free-float to increase,” says Lim, noting that the Indonesian government offers tax breaks to firms with more than a 40% free-float. “Over time this free-float increases and this MSCI rating will increase in order to reflect this increased liquidity.”

On the production front, Lim notes that manufacturing wages in Thailand, the Philippines and Vietnam are now competitive with China, while foreign direct investment is flowing back (see graph, right) as corporations recognise that the focus is shifting from exports to domestic consumption.

Lim flags a domestic pick-up in investor investment too, particularly into infrastructure development. Gearing levels in Asean countries are relatively low as a result of deleveraging following the Asian financial crisis of 1997/98.

“But over the last few years GDP growth has been very strong, largely driven by consumption growth,” he says. “Now it is getting to the point that these countries need to restart their infrastructure development.”

He expects the reinvestment cycle to be facilitated by falling interest rates and an improved political environment, with positive sentiment having emanated from the election of Susilo Bambang Yudhoyono in Indonesia in 2009 and Benigno Aquino in the Philippines last year.

“Business interest has picked up a lot and there is a lot of interest to start reinvesting,” he states.

The Baring Asean Frontiers Fund has seen a 40.3% gain since inception on August 1, 2008. It returned 37.4% last year and is down -4.4% to date this year. The fund has a minimum investment requirement of $5,000, an initial 5% fee and a 1.25% management fee.