Investment in Asia ex-Japan used to be an exotic diversifier, but now the region's powerhouse economies are the main driver of global growth. Nick Sudbury reports
Much of the impetus for the worldwide recovery is coming from the developing markets, in areas like the Asia Pacific. According to Citibank, global real gross domestic product is forecast to expand by 3.8% this year, with about 40% attributable to the fast growing economies of Asia ex-Japan.
In spite of this strong economic performance the returns for investors continue to be highly volatile. During the credit crisis the region’s main benchmark, the MSCI Asia Pacific ex-Japan index, lost almost two thirds of its value. It has now nearly doubled from the low in the first quarter of 2009, but once again, it is becoming increasingly choppy.
The most diversified option is to invest in one of the regional funds. In the last 12 months the best performer was the db x-trackers MSCI AC Asia ex-Japan with a return of 20.51%. This is listed on various exchanges and is available in several different currency denominations.
Its MSCI All Country Asia ex-Japan benchmark is a free float-adjusted market cap weighted index made up of 11 countries in the region. The largest exposure is China at 25%, followed by the Republic of Korea with 19%, Taiwan at 15% and India, which makes up another 12%.
Manooj Mistry, head of db x-trackers UK, says the best performing component over the last year was Thailand with a gain of 49%. This was followed by Indonesia at 42% and Malaysia at 39%, but because of the weightings it was China that had the biggest influence on the overall return.
“All of these countries have shown strong GDP growth,” says Mistry. “None have had the same degree of fallout in the banking sector and because of this they have emerged from the downturn quicker than the developed economies in Europe and the US.”
Another good option was the iShares MSCI AC Far East ex-Japan, with the London listed ETF increasing 19.59% in the last year. The fund offers a slightly different regional exposure made of nine countries, with the main exclusion being India. It currently has 411 holdings with a total expense ratio of 0.74%.
The PowerShares FTSE RAFI Asia Pacific ex-Japan ETF offers an interesting alternative to the normal cap-weighted approach. Its holdings are designed to reflect the fair value of the constituent companies based on their underlying fundamentals such as cash flow, dividend yield and book value.
The result of this calculation is that the country allocations are completely different, with the largest weightings being Australia at 41% and South Korea at 35%. Hong Kong makes up a further 15% but mainland China is less than 1%.
Tim Mitchell, head of specialist funds at Invesco Perpetual, says the fundamental index strategy is automatically drawn to areas of the market where there is value.
“Companies in Australia and South Korea look undervalued compared to areas like China where many stocks are trading on high PE multiples,” says Mitchell. “The FTSE RAFI ETFs offer a contrary view where we essentially buy cheap and sell the winners.”
As well as the various regional ETFs, there are also plenty of funds designed to track individual countries within Asia ex-Japan. These typically offer a higher level of risk and reward.
The top performer last year was the iShares MSCI Malaysia Index fund, with a gain of 39.27%. It also has the best record on a five-year view with an impressive return of almost 150%.
The ETF currently has 41 holdings with an average market cap of $10.08bn. In terms of the sector weightings its largest exposure is financials, which makes up almost a third of the portfolio. This is followed by industrials, consumer staples and utilities.
Malaysia’s economy grew at an annualised rate of 10.1% in the first quarter of this year, with the second quarter expected to show an expansion of 8.8%. The main driving forces are the high rates of corporate and individual savings, easy credit conditions and accommodative interest rates. This is also helping to strengthen the Malaysian ringgit on the foreign exchanges, which will further boost returns to investors.
Another source of good returns last year was India, with three of the top four exchange-traded products all benefiting from significant exposure to the country. The products in question include the First Trust ISE Chindia Index, iPath MSCI India Index ETN and the WisdomTree India Earnings, with each rising more than 30%.
Not surprisingly the country in the region with the largest number of associated ETFs is China. The diverse range of different products allows investors to pick and choose exactly what sort of exposure they want to the world’s second largest economy.
One of the better known options is the iShares FTSE/Xinhua China 25 Index. This consists of a concentrated 25-stock portfolio of mega caps like China Mobile, Bank of China and China Telecom. It has had a quiet 12 months with a return of just 7.57% but is up an impressive 145.83% over five years.
Investors who want more small and mid-cap exposure can use the Guggenheim China Small Cap ETF. This has a much more diversified portfolio consisting of 155 holdings and has been a strong performer with a gain of more than 30% in the last year.
The US-based ETF provider Global X recently launched a series of six funds linked to different sectors of the Chinese market. These track areas as diverse as technology, financials, energy and consumer.
Evelyn Hu, vice president at Global X Management, says that a few years ago the only ETFs providing exposure to China were all based on the largest and most liquid companies.
Hu says: “Any investor who thought they owned China in their portfolio with such broad ETFs was actually overexposed to the financials or resources sectors and completely missed out on many other parts of the economy.”
The China sector ETFs allow more targeted directional positions than would otherwise be possible. Sophisticated investors may also use them to neutralise any over-weightings in a broad-based ETF by going short in the relevant sector funds.
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