beyondbrics

By Aoifinn Devitt of City Financial

Capturing the growth potential of Asia’s promising but immature markets is a process plagued by inflation fears, volatile fund flows and other bumps in the road – not to mention investor flight when global political risk spikes and jitters run high, as they have in recent weeks.

Winning funds focused on broader Asian growth will be those that embrace the less sensational, mature, economies, which – although not immune from flights to safety and turns in risk appetite – present a counterbalance to the adolescent frenzy of their emerging neighbours.

The past three months have seen a subtle shift in the investment darlings of Asia. A dichotomy has emerged between the growth engines of China, India and southeast Asia, and the more developed economies of Taiwan and northern Asia.

Chinese indices have been particularly affected by fears that ongoing monetary tightening will crimp growth, with acute volatility in the financial and property sectors.

Meanwhile, price rises and margin compression have eroded investor enthusiasm for consumer stocks. Indian markets have been roiled by the same inflationary forces, with corporate and political scandals further complicating the mix.

Low liquidity makes markets in southeast Asia more volatile than other regional bourses, which as well as being more liquid offer more complex instruments and hedging opportunities (particularly in Japan and Taiwan) than their less mature neighbours. But even mature markets experienced severe pressure in January, bearing the full brunt of both inflationary jitters and political risk.

Shared features of the best performing indices in recent months are export orientation, muted growth, maturity, and insulation from the severe inflation pressures besetting the surrounding region. Korea, for example, is highly dependent on aggregate global demand, with gross exports representing more than 40 per cent of GDP.

While Asia ex-Japan represents the majority of this demand, it is closely followed by the G7. Higher end tech producers such as Samsung Electronics and LG Electronics have thrived as demand for smartphone and tablet style mobile computer devices has proved insatiable on a global level.

As in the case of Taiwan, markets seem to have priced in the occasional flare up of political tensions in South Korea (most recently tested in November of last year) and the long term effect of these developments has been muted.

In Taiwan, the market has moved distinctly out of step with other Chinese indices due to its strong technology and export orientation. For example, it strongly outperformed in the months of November and December, while trailing since the beginning of the year.

These markets will never lead regional sentiment, so may not be at the epicenter of hot money flows, but they will be levered to indications of global recovery, thus presenting a good hedge when fund flows shift from developing to developed markets (as we have seen so far in 2011). They are also particularly focused on technology, a sector riding high on sentiment and consumer demand, and one that seems to have broken out from other sectors in terms of returns and valuations globally.

That said, a fund strategy exclusively focused on these regions will miss out on two important forces shaping the dynamism in Asian markets today.

The first is the steady pace of new deals. The new issue market in many mature economies remains sluggish, even though in Hong Kong, Singapore and Taiwan new deal volume has picked up significantly since the start of the year after a fallow spell following November’s market correction.

The second is the staggering projected growth in, for example, internet penetration, car ownership, and domestic tourism. This has dizzying implications for the growth of brand leaders, in particular internet companies in China and developing Asia such as Tencent and Baidu.

The story of growth in Asia is not a new one, but much of the low hanging fruit has already been picked and the messy realities of that growth are now roiling investor sentiment.

However, this early energy has opened up a new, more complex chapter, where the plot lines are becoming more fragmented and scattered. Profiting from this next phase will require a more inclusive approach towards the older generation of markets as well as a more sophisticated set of techniques to add value – or “deliver alpha” – beyond the traditional “buy and hold” approach that worked so well in the past.

Aoifinn Devitt is the portfolio manager of the City Financial Asian Absolute Growth fund, a fund of hedge funds focused on Asia

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