devan kaloo, far east fund manager at aberdeen, believes the region has learnt from the lessons of the 1997 crisis
A big change in the way Asian companies think and behave means that investing in the Far East ex-Japan region is more attractive than it has been for 10 years.
That is the view of Devan Kaloo of Aberdeen's Far East Emerging Economies Fund.
'As a result of the emerging markets crisis in 1997 Asian companies' behaviour has undergone a big overhaul. Balance sheets have improved, profitability is rising, but valuations are low compared to the rest of the world. Added to a positive economic backdrop it makes a very good story for Asia ex- Japan,' he says.
To understand the significance of this investors have to put the current situation in the context of Asia's recent performance.
'In the 1990s, strong economic growth did not lead to good stock market performance because that economic strength did not feed through to profits,' says Kaloo. 'Minority shareholders were bottom of the list of priorities for companies and governments and very little if any profits came through to them.'
Kaloo believes that what happened in 1997 has forced changes on the region with the biggest reforms coming in at the corporate level. Companies with strong core businesses, for example, no longer invest into non-core areas they knew nothing about, a policy exposed after 1997.
'Take Korea's Samsung Electronics, one of the Aberdeen fund's biggest holdings,' he says. 'In 1997 the company was struggling badly. Its debt to equity ratio was over 200% and it had diversified away from its core semiconductor business into things such as financial services and car manufacturing. Now it has sold off the non-core assets, paid down its debt and has started to buy back its shares. It has relatively good corporate governance as well.'
Healthy domestic demand is helping the corporate clean-up story.
'Nearly all of the countries in Asia, bar Hong Kong and perhaps Singapore, are enjoying housing booms fuelled by banks lending to consumers,' says Kaloo. 'After the financial crisis of 1997, when they suffered badly because of too much corporate lending and bad practices, the banks have had to restructure and reassess risk.
'They have rediscovered the consumer. High savings rates, low interest rates and high penetration of consumer credit are all positives for Asian domestic demand and this is providing a major fillip for companies in the region.'
A decline in fixed asset investment is another prop. Kaloo adds: 'A lot of growth in the early 1990s was fuelled by investment in unproductive assets. The 1997 crisis caused this to fall off a cliff and precipitated a huge decline in capital expenditure across the region. As capital spending has fallen, companies have used rising cashflows to pay down debt. And as debt has been paid off the increasing free cashflow is being returned to shareholders.'
The Far East Emerging fund itself now yields 3.3%. According to Kaloo 1997's problems have also resulted in a dramatic improvement in accounting standards across the region.
'In many areas you get better disclosure, more timely reporting and consolidated annual reports, so it is easier for investors to make better informed decisions,' he says.
This improved visibility makes the valuations in Asia attractive compared to the rest of the world. Asia ex Japan sells on 14 times earnings compared with the S&P 500's 35 times.
'It looks very cheap and with improving profitability companies have less debt and a higher return on capital than most of their counterparts elsewhere in the world,' he says.
One reason for the valuation discount is the problems investors have had in the past but Kaloo believes old themes such as Asia being a warrant on US growth are now overplayed. Exports are a large portion of Asian companies' business but now domestic demand is really coming into its own.
Kaloo also sees a lot of opportunities in the southern Asian countries such as Thailand, Indonesia and India as well as the traditional investor's favourites of Korea, Taiwan and China.
In the south the companies 'work harder for their capital and are valued more cheaply,' he says.
The threat of China dominating the region is also overplayed, he believes. He expects that if manufacturing does move to China, it will offer countries such as Thailand the chance to develop more balanced economies.
The US did this very successfully in the 1980s when it built up its service industries.
The biggest risk to Aberdeen's bullish outlook is if reforms stutter and companies do not follow through with restructuring. Kaloo aims to overcome this potential problem through the right stock selection.
Aberdeen uses a number of parameters for picking its shares.
'First is corporate governance. We won't invest in a company we haven't met and we look for the people who have got the shareholder value religion,' says Kaloo.
Other criteria are good managerial track records, a strong balance sheet, with particular emphasis on debt structure and the currencies of any debt, and a competitive business model.
Domestic economic/demand plays such as banks and consumer stocks offer the better opportunities in the current climate. 'Tech companies are still expensive due to weak external demand and low demand,' says Kaloo.
Some of the traditional risks of investing in Asia do remain. The US going into a double-dip recession would hurt and have a big knock on impact on domestic economies, though this scenario is not what Aberdeen predicts.
A war with Iraq could spark a capital flight back to the more developed economies while if Japan's bank system did fail and the yen slumped, that would hurt the competitiveness of the Asian companies.
SPEAKER: Devan Kaloo
MA (Hons) in Management & International Relations, University of St Andrews.
MSC in Investment Analysis, University of Stirling.
Joined Martin Currie in Edinburgh shortly after graduation, working on the North American Desk before transferring to the global asset allocation team. Spent three years working on Asian portfolios.
Joined Murray Johnstone in Singapore in July 2000. Aberdeen acquired Murray Johnstone in December 2000 and Kaloo transferred to Aberdeen as fund manager to work with the Asia ex Japan team.
Specific responsibility for North Asia and India and is also involved in regional portfolio management.
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