This is part of an AsianInvestor series on the investment outlook of fund managers with Asian portfolios.

Kannan Venkataramani is an investment director for Asian equities ex-Japan at Prudential Asset Management. Based in Singapore, he is responsible for managing core Asia ex-Japan retail funds as well as emerging Asia mandates. He has more than 13 years of investment experience.

Prudential Asset Management, which is part of Prudential Corporation Asia, manages around $74 billion, including around $48 billion in Asian equities. Prudential Plc manages more than $530 billion worldwide.

What are the biggest opportunities that you see in the markets you are responsible for in the coming 12 months? How are you preparing to take advantage of those opportunities?

Venkataramani: The markets have sold off on fears of inflation and a slowdown in global growth. At Prudential Asset Management, we take a long term view on investments and we remain convinced about the medium term structural growth story in Asia. We believe that domestic consumption and investment growth will be strong enough in several countries to offset the slowdown in export growth.

We see the biggest buying opportunities in stocks that are leveraged to domestic demand, especially in emerging Asian markets, that have been sold off in line with the broader markets. In todayÆs volatile markets, we would look to build our positions in such stocks.

How different or similar is your 12-month investment outlook now compared to the start of this year?

At the beginning of the year, we were concerned about earnings risk due to slowdowns in export growth. Today, we have added inflation to our list of worries. This has led to earnings downgrades and this trend looks set to continue for some time. As a result, we are more negative on export-oriented sectors, such as information technology.

On the positive side, since the beginning of the year valuations have come off sharply and we are now looking at reasonable multiples even in the case of growth markets such as India and China. While we are still concerned about the macro situation in India, we have turned more positive on China where we feel that the Chinese economy is better equipped to handle inflationary pressures.

Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?

In the last few months, we have reduced our weighting in export-oriented sectors, and increased our weighting in domestic demand-oriented sectors. This has been driven by our relative view on Asian growth vis-a-vis OECD growth.

We have increased our weighting in defensive sectors such as consumer and telecommunications. We have also increased our weighting in China and the Philippines, mainly driven by valuation considerations.

What are your favoured markets in Asia?

Our favourite markets in Asia are China and Taiwan.

In China, we believe the sharp correction in the market has made valuations attractive. We expect the pace of economic growth to slow down as China weathers the global downturn and fights inflationary pressures at home. However, we believe the medium-term structural growth story remains intact.

TaiwanÆs valuations are attractive and specifically, the dividend yield is good, which helps during volatile times. Improved cross-strait relations and increased infrastructure spending are two major drivers that could help boost the domestic economy at a time when the export sector battles a global slowdown.

What are the markets you are going to steer clear of in the coming year?

We are underweight in Korea and Hong Kong.

The Korean economy and the Korean stock market are exposed to global consumption and global cyclicals, both of which are not appealing at this point in time. We believe that the risk of earnings downgrade is high, which could make the apparently cheap valuation more expensive.

We expect the Hong Kong economy to be negatively impacted by the growth slowdown given the economyÆs close relationship with global trade. Valuation is more expensive than the region, seemingly ignoring this risk, and hence the market is relatively unattractive.

What are your market weightings within an Asia ex-Japan equities portfolio?

We have the following weightings in a typical portfolio:

China: 26%
Hong Kong: 9%
India: 8%
Indonesia: 7%
Korea: 17%
Malaysia: 2%
Pakistan: 0
Philippines: 2%
Singapore: 6%
Sri Lanka: 0
Taiwan: 20%
Thailand: 3%
Vietnam: 0

Which sectors do you expect to outperform in the coming year?

We expect the financial and telecommunications sectors to outperform in the medium-term.

Financial stocks have been beaten down in sympathy with global credit related issues and rising domestic inflation, bringing them down to very cheap valuation levels. However, we believe that a combination of underleveraged household balance sheets, low asset ownership and high savings ratios would drive growth in the medium-term.

Telecommunications stocks offer the dual benefit of continued growth driven by under-penetration and a defensive character backed up by strong cash flows and dividend yields.

Which sectors do you expect to underperform?

We expect industrials and material stocks to underperform in the medium-term.

Industrial stocks are likely to be affected by rising raw material costs, which would put margins at risk. Aggregate valuation is not attractive enough despite the sharp correction year-to-date.

Commodity prices and commodity stocks have performed very well in recent years. However, as demand slows down, these stocks are likely to go through a cyclical downturn. Headline valuation remains attractive, but downward earnings adjustments could be very sharp if the cycle turns.

What are the main challenges that you expect to face in the coming 12 months?

The sharp rise in oil prices is among the biggest challenges facing the markets at this point in time. Higher inflation due to rising oil prices has led to monetary tightening by central banks in many markets. This could lead to slower growth going forward.

What are the main risks of investing in Asia at the moment? How are you managing those risks?

The key risks for Asian markets are higher oil prices and the resulting inflationary pressures leading to margin squeeze, especially in cases where pricing power is absent; political risk, driven by the recent and upcoming changes in government in various countries; and a prolonged slowdown in growth in OECD countries.

We manage these risks by taking a diversified exposure across sectors and countries, with an emphasis on domestic growth.