The Case for Asian Equities

By Michael Marusiak and Michael Reynal, Co-Heads of Asian Equities, Principal Global Investors.

The case for investing in Asian equities is based on two long-term themes: increasing domestic wealth and the integration of Asia into the global economy; and further supported by four short-term themes: attractive valuations, low relative interest rates, a booming consumer sector, and high relative GDP growth.

Today, nearly 45% of the world's population lives in Asia. By 2010, nearly 60% of the world's population between the ages of 20-34 will live in Asia . GDP per capita is increasing sharply across the region. Between 1999 and 2003 Chinese GDP per capita increased from $791 to $1100. In addition, the huge consumer class created by the shifting demographics of Asian countries will be larger than the Baby Boom generation in the United States. The combination of these two effects is expected to lead to greater consumption and an expansion of credit, which presents attractive opportunities to investors in Asian equities.

  P/E
2004
P/E
2005
P/E
2006
MSCI AC Far East Ex Japan 10.6 11.1 9.9
MSCI EAFE 14.5 13.6 12.5
S&P 500 16.6 15.5 13.9

 

A second investment theme is the global growth in trade and outsourcing. Corporations around the world are taking advantage of outsourcing as a way to stay competitive and improve their bottom line. Asia is the primary benefactor, thanks to the large pool of inexpensive, skilled labor. Interestingly, we see a sharp pick up in outsourcing of services as well as manufacturing and processing. Asia remains a large exporter of goods as well as services, with China taking on a leading role in global trade activity. A new development has been the dramatic increase in trade flows within Asia, resulting in another layer of internal economic activity.

Companies in Asian markets trade at significant valuation discounts to those in developed nations. As can be seen in the chart below, our research suggests Asia still trades at a significant discount to the EAFE region and the U.S., with higher earnings growth. Although the valuation is mixed, with Korea being perennially cheap, and Malaysia traditionally trading at a premium, Asia overall does look undervalued relative to the developed world, especially considering its superior growth profile. Asian markets have still not recovered pre-1997 crisis valuation levels. We would expect these markets to gradually close the valuation discrepancy and trade more closely in line with developed markets.

Although interest rates in developed markets are now rising, they are still at sufficiently low levels across Asia that the returns on offer in the Asian markets are attractive to global investors. History shows that Asian markets benefit from global liquidity and low interest rates that stimulate the cyclical economies of Asian countries. As indebted countries find it easier to borrow, sovereign credit spreads tighten, and Asian securities become more attractive. Global investors expand their appetite for risk as they become attracted to opportunities for increased returns. Asian companies have de-leveraged significantly in the nearly 8 years since the Asian crisis, and remain relatively immune to a hike in global interest rates. Furthermore, the high savings rate among most Asian countries provides a cheap pool of capital from which companies and governments can borrow. A number of countries in Asia are developing private pension schemes, which will provide an additional source of capital and help re-rate the markets.

Bank extension of credit and credit cards are becoming increasingly popular in the retail segment and credit card penetration rates are rising in many Asian countries. Moreover, mortgages are growing alongside the increase in housing demand. This is a result of deliberate government policies such as subsidized mortgage rates across Asia. The banking and property sectors stand to benefit from this expansion of credit. The expansion of credit is a long-term secular trend and will not be affected by a short-term pick up in interest rates. We believe many consumer companies will benefit over time from the increased activity of the Asian consumer.

Asian markets act as a marginal producer to global industries, and their economies benefit directly from increased production in industrial activity. Although global growth is set to slow somewhat in 2005, trade flows remain extremely high by historic standards. We do not see a significant slow down in trade activity in the medium term, and believe that a number of Asian companies, in the shipping and logistics industries for example, will continue to grow at above average rates. This growth is more tied to intra-Asian trade, and so should be relatively insulated from any global slowdown in trade flows.

Investment Capability

Principal Global Investors' equity group has been managing equities for over three decades and currently manages over US$28 billion in domestic, international, and emerging markets equity portfolios. We have successfully managed dedicated Asian equities portfolios for more than a decade. Our Asian equity investment philosophy is based on the belief that superior stock selection is the key to consistent outperformance. Superior stock selection is achieved by a combination of systematically evaluating company fundamentals and in-depth original research. Principal Global Investors focuses on four critical drivers of stock performance: improving business fundamentals, sustainable competitive advantages, rising investor expectations, and attractive relative valuation. To leverage our stock selection skills as the primary drivers of relative performance, we seek to maximize global information advantages and neutralize unintended portfolio risks.

Our investment process is distinct in its harmonization of quantitative and fundamental investment analysis. The heart of our quantitative process is the Global Research Platform, a stock-ranking tool that ranks every stock in our universe on the basis of a number of factors such as valuation, earnings revisions and price action. This provides us with the ability to make unemotional buy and sell decisions and to deliver to our clients not only consistent returns, but without any style drift. Our portfolios are designed to deliver superior risk adjusted returns in all markets, with the attribution of those returns always given by strong stock selection, never by market timing or style drift.

Disclaimer:

"This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied upon as such. This material is given in good faith and has been derived from sources believed to be accurate as of May 2005. Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions herein. This presentation is issued in Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary Authority of Singapore."

For more information, please contact:
James C. Sim
Director, Regional Head of Marketing, Asia
Principal Global Investors
Tel: +65 6490 0281 Mobile: +65 9632 9976
Fax: +65 6333 6778
[email protected]
www.principalglobal.com

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