Liquidity might be tighter these days, but careful asset allocation to emerging markets should give investors a smooth ride
In the heady days of the dotcom boom, asset allocation became a forgotten or rejected art. Stockpickers were the headline-grabbing sharpshooters and getting the big picture right was simply a backdrop to their skills. Recently, however, like a lot of other pre-TMT techniques and features, asset allocation has once again proved its worth.
Investors are belatedly waking up to the fact that not all equity markets are suffering the same gut-turning plunges as the S&P500 or the FTSE 100. Two of the best performing markets in the world year-to-date have been Russia and Korea, indicative of the growing interest in emerging markets generally.
While the crisis in Argentina has blocked substantial money flows to Latin America, the Pacific region ex Japan has benefited. Investors have not forgotten the Asian currency crisis of 1997-98, but there is a strong perception that lessons have been learned from it. A decade ago, the attractions of emerging markets were the demographics, where younger populations would drive double-digit GDP growth, and the low correlation of the asset class with developed markets.
Both still hold, especially the latter. Asia ex Japan now has a greater weighting in global indices, but according to Standard & Poor's, the average Asian exposure for funds is 52% compared with 47% a year ago. The region boasts some world-class companies trading at realistic valuations. After ongoing reform at both government and corporate levels over the last five years, these organisations are proving resilient to the global economic downturn.
Have the tigers turned defensive? Investors seem to think so, returning to the smaller Asian markets that were sold off so decisively in the late 1990s. Liquidity may be tighter, but try selling a tainted telecom stock in developed markets. Corporate governance may be underdeveloped, but nothing on the scale of Enron, WorldCom, or Tyco has blown up yet.
Funds which got their asset allocation right in Asia this year have done well, no matter what their size or investment style. Both growth and value-orientated managers have outperformed regional indices. Those with stockpicking abilities have secured extra gains. Furthermore, since emerging market teams within investment houses were decimated by the 1998 crisis, they have not been so affected by recent redundancies. With Asia accounting for a third of the world by market cap, cost cutting in this area could only go so far. Stability and experience has proved a winning combination, and the ratings of many emerging market funds are actually being upgraded.
Sceptics warn that emerging markets are only benefiting because there are no compelling investment opportunities elsewhere. As soon as developed markets revive, they say, there will be a 'flight to quality' again, leaving these small markets high and dry. The problem is, even the optimists are beginning to rethink the scenario of a rapid return to growth for developed markets.
And these days, quality hides in surprising places. The most interesting thing about Asia is that this time round, it is not foreign money that is underpinning local markets. Savings levels remain among the highest in the world, but domestic consumption and investment is rising, starting the virtuous cycle that those who advocated the sector always promised would occur.
In the early 1990s, it was US companies (and their shareholders) using cheap labour and materials that were benefiting from their Asian exposure. Going forward, there is far more depth and self-reliance in regional economic growth. Most Asian markets, and many Asian companies are expanding despite the turmoil in the global economy. The fundamentals are clearly intact and the gains sustainable.
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