This is part of a mid-year AsianInvestor series on the investment outlook of fund managers with Asian equity portfolios.
Lee Sang-Hoon is an investment director for Asian equities at Prudential Asset Management (Singapore). Sang joined Prudential in 2005 and manages Asia ex-Japan funds as well as Korea country funds with combined assets of around $500 million. He has more than 14 years of investment experience.
Prudential Plc has £249 billion in assets under management, including around £36.8 billion in Asia.
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?
The world economy, however, still faces the issues of consumer deleveraging in the developed economies and over-capacity in developing economies, especially Asia. These issues may remain over the next few years. Nevertheless, there are some countries, sectors and stocks that look relatively attractive. China, for example, has a fiscally strong government that can help offset weak export-oriented manufacturing sectors and its stock market looks undemanding in terms of valuations. Infrastructure sectors in emerging countries such as China and India have a healthy growth outlook over the next several years on the back of a constant need to boost their under-invested infrastructure and on-going strong support from their government spending. At stock levels, the companies with strong market positions and healthy balance sheets can take advantage of slower business conditions to expand their market share and widen the competitiveness gap with weaker peers.
How different or similar is your 12-month investment outlook now compared to the start of this year?
Our view on the market hasn't changed extensively. Prudential Asset Management normally takes a long-term view on the market.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
No. I haven't made any significant changes to my fund positioning.
What are the greatest lessons you have learned from the global financial crisis and how will this affect the way you manage your portfolios?
The crisis is no different from other downturns, such as the IT sector collapse in 2001 and the Asian crisis in 1997, in that there were strong signs of a bubble being formed -- especially given the excessive valuations of equities, commodities, housing and credits. Some experts with reliable credentials warned about the likelihood of a downturn, however, the market consensus ignored these warnings, blinded by new theories developed by market cheerleaders to justify the bubble. At Prudential, we try to focus on valuing a stock on the basis of its normalised and long-term sustainable returns and avoid any names with stretched valuations that cannot be explained from a sustainable return perspective. This same principle can be applied to a market as well.
How has your view of Asian equities changed since the start of 2009 when investor sentiment was generally gloomier?
My view on the market hasn't changed much. I normally take a three-year view on the market and the main opportunities and risks for the next three years are already mentioned above.
How has the swine flu affected your investments?
There has been no impact.
What are your market weightings within an Asia ex-Japan equities portfolio?
China - 33%
Hong Kong - 7%
India - 8%
Indonesia - 0%
Korea - 16%
Malaysia - 5%
Pakistan - 0%
Philippines - 3%
Singapore - 6%
Sri Lanka - 0%
Taiwan - 13%
Thailand - 5%
Vietnam - 0%
What are your favoured markets in Asia?
China, Thailand and the Philippines. China has a good balance between domestic and export sectors in terms of contribution to economic growth and a fiscally sound government that can provide a reliable cushion to a downside risk to the economy. China's valuations are at a slight discount to the regional market. Thailand remains the cheapest market in the region and its political risk appears to be over-played. The Philippines enjoys a benign credit cycle which, coupled with a resilient remittance from its overseas workers, should support relatively stable domestic growth over the next few years. Its valuations have now de-rated to a more reasonable level.
What are the markets you are going to steer clear of in the next 12 months?
Korea, Taiwan, Hong Kong. These are all small and open economies that are very vulnerable to weakening in global demand. Except for Hong Kong, these countries have high consumer leverage and weak banking sectors in both absolute and relative terms that will constrain domestic consumption growth. All of the markets are currently trading at above mid-cycle valuations.
Which sectors do you expect to outperform in the next 12 months?
Consumer, infrastructure-related industrials, energy, telecoms and utility sectors. We expect these sectors to deliver relatively healthy growth in earnings and cash flow. Consumers and infrastructure-related industrials have relatively high valuations but this can be justified by strong long-term growth potential. Energy especially oil and gas has more balanced long-term supply and demand conditions compared with other commodities. Telecoms and utilities in emerging countries have reasonably strong growth potential while their valuations have de-rated recently.
Which sectors do you expect to underperform?
Materials, downstream chemicals, shipping and shipbuilding, and the financial sector. There is a severe oversupply in the steel, downstream chemical and shipping and shipbuilding sectors which is likely to take several years to resolve. Financial sectors in Korea, Taiwan and India are already shaky and are vulnerable to the risk of a further rise in credit costs and re-capitalisation if global growth remains subdued for an extended period of time. The high growth in the Chinese banking sector is driven mainly by government policy which makes for unfavorable future risk and rewards.
What are the main challenges that you expect to face in the coming 12 months?
A double dip in the economy. The sequential recovery in the economy we've seen in the first half of the year has been driven mainly by inventory re-stocking and government pump-priming. Some governments in the region like China can sustain their aggressive spending for longer but others may not have this ability. As such, if the current recovery is not followed by a turnaround in real demand, it could fizzle out.
Another risk is interest rates and liquidity. The monetary policies of Asian central banks are linked to a great extent to that of the US Fed. The Fed's policies are mostly directed toward solving the domestic problems of the US so they can have unintended consequences for Asia. Risks related to this include asset bubbles and inflation in case the Fed's easing lasts too long and vice versa.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
There are several structural issues. One is heavy government intervention and regulation which makes it difficult to forecast the long-term sustainable returns of regulated companies and the values based on them. The second issue is weak corporate governance. The current financial turmoil has exposed some badly managed companies and I expect there will be more to come if the turnaround in the global economy is delayed.