It wasn't that long ago that Asian economies could do no wrong, what with their double-digit growth rates, expanding middle classes and legions of educated young people eager to spend.
Now that these onetime firecrackers have mellowed out, however, the key question for advisors (and, of course, investors) is how to approach Asia now.
Robert Horrocks and Kenny Lowe, managers of the $4.1 billion Matthews Asian Growth & Income (MACSX) fund, believe the region still has great promise. The factors that drove the region's explosive growth earlier in the century are still at play, Horrocks says: high savings rate, improving educational systems and openness to new ideas. "Asia has that in spades," Horrocks says.
Yet it's hard to ignore the slowdown. In 2013, Asian economies are expected to have expanded 7.1%, down from 7.5% the year prior. China logged a 7.7% growth rate last year, down from 7.8% in 2012; and many analysts expect further slowing this year.
Fed policy doesn't help. Because U.S. interest rates influence borrowing costs around the globe, the Fed's loose monetary policy since the financial crisis has given other countries access to easy money; as that cycle comes to an end, countries with current account deficits, such as India and Indonesia, get hit particularly hard.
Even so, Horrocks believes Asia can outpace developed markets' growth by four percentage points a year. And while growth is a tailwind for stock-pickers, Horrocks says, the real focus needs to be on finding great businesses.
One key point made by the managers employed by San Francisco-based Matthews International Capital Management, a firm that invests extensively in Asia: Investors need to view Asia separately from other emerging markets. And even within the region, there are nuances. China, Singapore, South Korea and Taiwan are hardly emerging anymore, and markets such as India, Indonesia and Thailand offer opportunities unique to their regions.
Matthews Asian Growth & Income is a bit unusual because while the managers believe in the region's growth potential, they also try to mute some of the volatility common to fast-growing economies by focusing on dividends, convertible bonds and preferred stocks. According to Horrocks and Lowe, the fund is able to realize more than half of the upside of market rallies, but less than half of the downdrafts. It's a way for gun-shy investors to stick with Asia, instead of bolting when things turn dicey.
Of course there are downsides to playing it safe. "If you get an abrupt rally in the market, this fund won't keep up," Horrocks says. "But if you take a strategic view of Asia, then you might want something like this."
The fund's results reflect that. Over the three years ended Jan. 31, as Asian markets have faltered, the fund is up an average of 4.9% a year annualized, according to Morningstar - besting 88% of its Asia-Pacific ex-Japan competitors. But over the five-year span ended Jan. 31, a time period that reflects the credit easing cycle in Asia, Matthews Growth & Income was up 14.7% a year annualized and in the category's bottom 23%.
When it comes to finding the 50 or so names for the portfolio, the managers like companies with reliable management teams and sustainability. "Look a decade and a generation out," Horrocks says. "Will this company still be there?"
The managers also look for a clean balance sheet, competitive advantage and financial transparency. That's why many holdings are domiciled in places like Hong Kong and South Korea that have well-established financial markets.
Lately, they've also taken a shine to Thailand, which has seen markedly improved transparency and rising dividends. Horrocks and Lowe like BEC World Public (BECVY), a Thai television broadcaster. "It's one of the biggest and most popularly watched TV channels," Horrocks says. Nearly 82% of revenues come from advertising, with the rest coming from concerts and copyrights. And state regulation mandates how many ads can be shown per hour, giving the company strong pricing power.
The company recently won digital broadcasting rights for three channels. The hefty price tag for those rights - about $200 million - caused shareholders to fear it will place a burden on capital expenses. Shares are down 13.7% for the 12 months through Feb. 19.
Elsewhere, China still presents ample opportunities, even during a slowdown. But Chinese banks aren't the way to play that theme. Successful banks must manage underwriting, operating expenses and capital requirements, all big undertakings. "When I look at China, I don't see that they manage all these things particularly well," Lowe says. What's more, he says, the country hasn't been through a credit crisis that compares with the one experienced by developed markets in 2008 and 2009. "We like to understand whether a management team can deal with these kinds of issues," he says.
The managers prefer insurer AIA Group, which also provides retirement plans, as a China play. Formerly owned by AIG, the firm was listed on the Hong Kong exchange in 2010, allowing AIG to recoup a portion of its bailout money. And the AIG parentage continues to be favorable for AIA. Despite its name, AIG was founded in Shanghai in 1919 - a heritage that allows AIA to sell term life insurance in China, which few other global insurers can do.
Horrocks also sees AIA as a way to take advantage of improving financial conditions in less economically developed markets around Asia. "It's domiciled in Hong Kong, but it also has a big presence in Thailand and Singapore," he says. Shares are up 19.5% for the year ended Feb. 19.
The fund also aims to cut risk by investing roughly 10% of its assets in convertible bonds. One such bet is Hong Kong Exchanges and Clearing, the world's fifth-largest exchange. While Horrocks likes the business, share prices can be volatile, he says: "The cash flow that is going through it is based on turnover, which is a product of investment sentiment and liquidity." The convertible bonds are largely immune from those worries, he adds.
SPLIT ON JAPAN
The managers are split when it comes to Japan, where a rally began in fall 2012, when the Bank of Japan moved aggressively to shore up the lagging economy. The loose monetary policy seemed to be effective at first, but the Nikkei 225 was off 11% for 2014 through mid-February, as investors began losing confidence.
Horrocks believes the program can work, but Lowe is unconvinced. He calls Japan's demographics "horrible," with fewer workers supporting more and more retirees.
He did, however, recommend an investment in Lawson (LAWS) - Japan's largest chain of convenience stores - in fall 2012, just before the changes in monetary policy were put in place. In the past, investors worried about the firm's poor inventory management and thought the local market was saturated. "You'd walk into their stores on a Saturday night and they would be completely out of bento boxes," Lowe says. But Lawson executives are getting smarter about inventory, he says.
"They're pushing on a number of levers for bigger top-line growth, and that filters down to higher returns," Lowe says. He believes the chain has room to add new stores. For the 12 months through Feb. 19, the stock was down 2.6%, however.
Ilana Polyak, a Financial Planning contributing writer in Northampton, Mass., has also written for The New York Times, Money and Kiplinger's. Follow her on Twitter at @ilanapol.
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Matthews Asian Growth & Income
Credentials: Ph.D. in Chinese economic history, Leeds University
Experience: Chief investment officer, Matthews Intl. Capital Mgmt. (2008-present); portfolio manager, Matthews Asia Growth & Income (2009-present); head of research, Mirae Asset Mgmt. (2006-2008); chief investment officer, Everbright Pramerica (2003-2006)
Inception of fund: 1994
Style: Pacific/Asia ex-Japan stock
AUM: $4.3 billion
3- and 5-year performance as of Jan. 31: 4.85%, 14.7%
Expense ratio: 1.11%
Front load: none
Min. investment: $2,500
Alpha: 2.48 vs. MSCI All Country World Index ex-U.S.