Conventional wisdom holds that Asia’s best equity story consists of tech stocks buoyed by investor momentum. That even if dubious dotcoms are no longer in fashion, incredible earnings growth and continuing demand from California make Asia hardware and telecom stocks today’s core holdings.
Not in Scotland. In the damp, gray fastness of Edinburgh, fund managers have a distinctly sceptical view. Most initial public offering roadshows have to travel here, and it is often the toughest destination for a company’s top brass. The grilling they get is frequently more severe, the questioning more dogged, than in other European capitals.
Scotland is a bastion of traditional long-term value equity investing. The style is considered quaint among most high-flying Hong Kong-based fund managers. But at a time when Nasdaq and the technology, media and telecom (TMT) theme are wobbly, a trip to Edinburgh offers a refreshing second look at Asia’s weakness – and strength.
Scotland the not so brave
Scots are the original emerging market investors. Standard Life Assurance, the biggest player, just celebrated its 175th anniversary. The origins of Colonial Stewart Ivory date to 1873. It was set up to run investment trusts for Scottish enterprises in the hottest emerging market of the day: North America. Martin Currie opened shop in 1881 following Scottish immigrants to Asia and the Americas.
“The Scottish archetype is being thrifty with money and having a Protestant work ethic,” says Ray Perman, chief executive at Scottish Financial Enterprise, a trade group. The investment community, today managing ú282 billion, developed when Scottish entrepreneurs amassed ridiculous fortunes in the industrial revolution, and Scottish houses invented vehicles such as investment trusts and emerging market funds. “The approach is still value investing, picking stocks, backing people – they’re keen on management,” says Perman. “They’re sceptical of concepts. In the short run they can get caught out – last year they were outclassed by dotcom investors. But over time, over 20 to 30 years, their performance is consistent.”
Scottish firms have little presence on the ground in Asia. Their clients are overwhelmingly British and American, and fund managers prefer to centralise their investment teams. “Foreign offices cost money,” notes Angus Tulloch, joint head of emerging markets at Colonial Stewart Ivory. He notes many Scottish firms are partnerships, and the partners prefer to maintain control by keeping the fund managers under their watch. Adds Jeremy Whitley, investment manager at Edinburgh Fund Management: “Local offices can get seriously bogged down in day-to-day trading and the local atmosphere. We can do fundamental analysis in the cool of light of Edinburgh.” With modern communications and plenty of company visits, investors say they can adequately cover their companies.
Roadshow grillings
Although Scottish names aren’t found in Asia, the size of the investment community and the weight of its top players make Edinburgh a necessary stop for Asian IPO roadshows. It is likely to be the toughest stop in Europe. “Visiting companies get a grilling here,” says Rodger Nisbet, investment manager at Walter Scott & Partners. “We ask CEOs what they make, what are their options, are they flying business class.” He says a recent Chinese delegation turned up to a luncheon late, and the company explained their corporate jet couldn’t secure immediate landing permission. It left a bad taste with investors, who wondered whether a company should come cap in hand asking for money while providing its top brass with a Lear Jet.
“There’s a small group of us here, so it’s easier for us to get one-on-ones, and there are fewer of us at luncheons,” says Angus Franklin, fund manager at Baillie Gifford & Co. Such an environment means money managers are able to pursue questions that a CEO can dodge at a big luncheon in, say, London. “At the same time,” Franklin says, “we really appreciate the efforts of companies that try to give us a straight answer.”
Scots are no Luddites – that setting for anti-tech rage is English – and they take credit for the steam engine, Dolly the sheep and much in between. But when it comes to investing in Asian tech stocks - even supposed no-brainers such as Taiwanese semiconductor foundries - Edinburgh’s fund managers are bears.
Says Colonial’s Tulloch: “We’re underweight Taiwan on valuation grounds. It’s entrepreneurial and interesting, but electronics is a cyclical industry, and this fact is not reflected in current valuations.” He holds an underweight position in Taiwan Semiconductor Manufacturing and nothing in United Microelectronics, for example. Profit-taking is ongoing at BlackRock International. William Low, director, says the firm is aggressively reducing its position in telecom and tech’s upstream companies. “There’s just a few games in town, such as China Telecom and Samsung Electronics, and we’ve eased out of those weightings.”
Alistair Veitch, vice-president at BlackRock, says the firm is concerned a slowdown in the US is going to impact Asia soon, and advises Taiwanese companies that are looking to fund capacity expansion - such as UMC - to hit the market as soon as possible, before rosy expectations of growth come under fire.
“It pays Taiwanese companies [such as foundries] to keep hitting the market for capital because the market is pricing in profits for five years which belie a cyclical company," he says. "Those kind of profits aren’t sustainable as companies raise yet more capital and create more capacity.”
Taiwanese tax trauma
Edinburgh is taking a closer look at tax issues facing Taiwan’s tech sector. The new government is considering repealing the tax breaks given to tech companies that expand capex. Worse, stock options are not being accounted for. Engineers are increasingly remunerated via tax-free share options valued on company books at steep discounts to stock prices. “If counted under US GAAP[Generally Accepted Accounting Principles], corporate earnings would be half,” says Tulloch.
Adrian Mowat, director at Martin Currie, says he is a long-term bull for Asian tech but believes for now investors are overweight the TMT sector. “We’ve cut our exposure in favour of local consumption plays,” he says. He also likes local banks such as Development Bank of Singapore or Bank of East Asia, which are largely ignored but posting fantastic stock-price gains. He thinks investors will have a hard time selling tech when a panic hits.
Franklin says he has also “pulled in his horns” on Asian TMT, although he likes its long-term outlook. He completely sold out of Pacific Century CyberWorks, which he says was way overvalued, and reduced his Hutchison Whampoa stake, with a view to buy on dips. His reason: fears of the external environment softening demand for Asia’s tech exports.
This in fact is the leading sentiment in Edinburgh. Tulloch for one predicts a severe correction on Nasdaq within three months. Says Margaret Weir, investment manager at Scottish Equitable Asset Management: “Analysts are still preaching upward momentum for Asian tech but I think forecasts will soon become more sober.” She is underweight Taiwanese hardware, for example, and believes names such as Samsung Electronics should trade better if the semiconductor business cycle is truly to last another 18-24 months, as most analysts argue. “I prefer old-economy companies that exploit technology,” she says.
Smooth road ahead
Despite this old-fashioned approach, most Scottish investors are bullish on Asia’s long-term prospects. Nisbet cites a 17th century mystic, Coinneach Odhar, the Brahan Seer, who apparently predicted the rise and fall of Highland clans, railroads, canals and the ultimate domination of the Far East. Nisbet also has reasons to like Asia based on economic fundamentals. He says the growth prospects in China and Japan make investing in Asia in the next year an exciting prospect.
Nor is tech anathema forever. Fund managers in Edinburgh expect a soft landing for the US economy, and once valuations for Asian tech companies return to Earth they will be compelling buys. “Our major decision is when to reverse the bet,” says Mowat. For now he’s building positions in domestic consumer plays such as LG Home Shopping, but at some point investors will have to return to tech.
Into this thicket will come not just Taiwanese hardware companies looking to expand capex, but mainland China’s state-owned enterprises. For the most part, Scottish firms did not participate in the IPOs for PetroChina or China Unicom. But that does not mean Sinopec or the second go for China National Offshore Oil Corp (CNOOC) will be in vain.
Few picked up the PetroChina IPO but some have bought in the secondary market. Tulloch and Whitley say they avoided the IPO because return on equity looked poor but oil at $30 a barrel took them by surprise; Tulloch now holds the stock. Iain Wells, portfolio manager at Scottish Equitable, says: “I quite like what I heard: plenty of potential to cut costs, incentive contracts for management, talk of retail development in the west. The presence of non-executive directors on the board showed a willingness to take minority shareholder interests seriously.”
Most investors were turned off by Unicom’s pitch. BlackRock’s Veitch explains: “Unicom was sold on ‘It’s large so you have to buy it’, but there were no projections or analysis behind it, making it just another index play.” Other managers cite the lack of independent research on Unicom. Investors were angered by the government’s raising the offer price at the last minute simply because China Telecom’s stock price had risen. “It just annoyed people,” says Whitley. Unicom does have its fans, though: Martin Currie and Baillie Gifford & Co. are the two Scottish houses that took positions. “A 10% price rise should not affect your long-term view of a company,” says Baillie Gifford’s Franklin.
Whither CNOOC and Sinopec?
Investors are wary. Mowat notes oil prices are unlikely to improve, making China’s oil companies less appealing. Low is wary of the government, which divested but did not privatize PetroChina, and he wants to see whether its management meets the tough targets before buying the stock. Generally, CNOOC left a good impression on its first attempt at a New York listing, while Sinopec is an unknown, and is viewed as PetroChina’s poor relation.
Tulloch says the key issue for upcoming deals is how their managements are incentivised. Nisbet adds, “All they have to do is be honest and present clean companies.” At the right price, investors will buy. Nisbet says CNOOC and Sinopec can expect tough questions about management ownership of shares, compliance with US GAAP, global comparisons of profitability, return on equity and transparency. Lastly, fund managers are fed up with what they see is a greedy government. The pulling of an attractive deal for CNOOC over price, as well as Unicom’s pricing increase, is remembered in Edinburgh.
