Peer under the bonnet of most emerging markets funds and what do you expect to find. A core portfoli...
Peer under the bonnet of most emerging markets funds and what do you expect to find. A core portfolio of stocks in basic industries and resources, a fair few banks and utilities maybe, with a sprinkling of capital goods manufacturers and the like thrown in for good measure. Right? Wrong.
Of course, most of these kinds of stocks would be represented but not as heavily as you might think. These days the managers of emerging markets funds are more likely to be found sifting through a pile of electronics magazines, than piling into gold mining shares.
There are good reasons for this. Electronics now account for around 55% of the MSCI Taiwan index, and 33% of the MSCI Korea index. Asian companies account for the lion's share of world output of key products like semiconductors. And these manufacturers are among the nimblest and most profitable in the world.
They have to be in order to survive. In the space of six weeks this summer, spot prices of 64 megabit DRAMs (dynamic random access memory) chips jumped by nearly 100%. It is not just spot prices that are rebounding.
The prices reflected in long-term contracts between the chip producers and their largest customers such as Dell, Compaq and HP have also begun to climb. After years of losses, many of the DRAM producers in Taiwan and Korea are snapping back into profit.
The foundries producing customised semiconductor chips are trying to stay ahead of an increasingly volatile market place that is producing rich rewards for those who get it right. Taiwan Semiconductor Manufacturing Company (TSMC) is the largest semiconductor foundry in the world.
Despite its size, TSMC has shown itself to be adept at spotting new trends and in meeting the demands of consumers. Indeed, the company is benefiting from a surge in business from both ends of the industry: on the one hand from the semiconductor design companies who have no fabs (fabrication plants) of their own; and one the other from the fully-integrated manufacturers like Philips or Motorola that find it cheaper to farm out their chip production to others.
Another company that is likely to benefit from the rebound in the prices of 64 megabit DRAM chips is Samsung Electronics of Korea.
Samsung is one of the world's largest producer of such chips with a 17% market share. Like TSMC, it has shown that it can get new products to the market ahead of its rivals. Having paid off more than US$3 billion of its debt at the end of 1998, Samsung is also expected to see its profits rise strongly next year.
Of course, what neither of these companies nor their competitors know for certain is how long the recovery in the price of 64 megabit chips will last. We believe that the medium-term prospects for these companies are good, although chip prices are likely to soften during the first half of next year, for several reasons.
First, demand for personal computers (and therefore of chips) tends to tail off after Christmas. Second, output will increase as improvements in production techniques are phased in (although the disruption caused by the recent earthquake in Taiwan will offset this to some extent).
At Schroders, we think the balance between demand and supply is likely to tilt back again in favour of the chip producers during the second half of next year.
This is because demand for personal computers is likely to pick up again after a lull in the run up to the new millennium; at the same time the introduction of new chip-making capacity is likely to slow.
Also, a shift by manufacturers towards a new type of DRAM chip, called Rambus, will squeeze the supply of the older chips, so helping to keep their price high.
That is good news not just for chip producers like TSMC and Samsung but also for manufacturers of personal computers such as Acer of Taiwan. Acer recently got out of the chip-making business (by selling a majority of its shareholding to TSMC), but it is benefiting in other ways too.
Orders for personal computers from IBM, Acer's biggest customer, are up strongly; the company has also recently signed up Dell Computers as a customer too.
That, together with the fruits of a recent restructuring of the business, should help to improve earnings from 1999.
Most semiconductor foundries in Taiwan are currently operating at full stretch. In consequence, chip prices are also being pushed up as customers bid for supply. Companies in South Korea are also doing well.
The merger earlier this year of Hyundai Electronics and LG Semiconductor cemented Korea's position as the world's largest producer of DRAM chips. Higher DRAM prices are expected to give the merged company a helping hand this year and next.
Indeed, many technology stocks in South Korea are enjoying a revival. Their earnings forecasts are being revised upwards. Strong demand worldwide for components for personal computers and telecommunications equipment is also proving a boon for the manufacturers of components.
True, interest rates in South Korea have recently risen again as the country's financial markets react to recent increases in US interest rates and worries over the efforts of Daewoo, one of Korea's largest chaebol, to restructure itself; but, at Schroders, we believe that the next two or three years could see a marked change in the fortunes of manufacturers of customised semiconductors.
Chia Ee Toh is head of research, Taiwan, for Schroder Investment Management.
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