Politics & Policy

Far Out

Asia gets almost no respect from U.S. investors.

What ever happened to Asia? Last time I looked, 3.5 billion people lived there — three times as many as in North America and Europe combined. Asia is the fastest-growing part of the world and already accounts for one-quarter of all global economic output. Yet Asia gets almost no respect from U.S. investors.

Part of the problem, of course, is Japan. Over the past decade, its economy has stagnated, and its stock market has disintegrated. The Nikkei 225, Japan’s benchmark index, has dropped 30,000 points, or 78%, from its 1989 peak. Stocks did not merely crash — they kept crashing. In the past three years, a period when recovery was always just around the corner, the typical Japanese mutual fund lost 60% of its value.

Then, there are the “Tigers” — smaller Asian countries that turned aggressively to capitalism 20 years ago and generated vast enthusiasm among investors in the mid-1990s. But that boom went bust in 1997, practically destroying the currencies of South Korea, Thailand, Malaysia, and Indonesia. Between July 1997 and June 1998, T. Rowe Price New Asia (PRASX), a relatively tame mutual fund that covered the region, fell by more than half.

As for China: Its stock market is almost a black box. Foreign investors are welcome to insert money blindly and hope that more comes out the other end. But there are minimal legal protections, poor financial reporting, and little transparency.

So it is hardly a surprise that many U.S. investors have concluded that international diversification means Europe — and maybe even a little Mexico and Canada — but not Asia.

Many mutual funds cater to this public view. Consider Julius Baer International Equity (BJBIX), a fund with a top rating (five stars) from Morningstar. Managers Richard Pell and Rudolph-Riad Younes can invest shareholders’ money anywhere outside the United States. At the end of last year, 85% of their assets were in European stocks and 7% in Asian stocks, even though the two continents have almost exactly the same economic output. The Baer fund has 10 times as much money invested in the stocks of Hungary than in the stocks of South Korea, Taiwan, Thailand, Hong Kong, China, and Singapore combined.

“Most international funds,” says Mark W. Headley, president of Matthews Asian Funds in San Francisco, “are more European funds in disguise.”

So, while investing in Asian stocks is not easy, concentrating solely on companies based in Europe and the United States could be a big mistake. “The radical bias against Asia has no rational justification,” Headley says.

In fact, there may be a decent argument for ignoring European stocks as a specific asset class for diversification purposes, but none at all for ignoring Asian stocks.

Since 1995, European stocks and U.S. stocks have been moving, first up and then down, in tandem. Their mathematical correlation has increased, so they no longer offer the balance that’s so important in a portfolio. As a result, my advice has been simply to buy the best companies, whether they are headquartered in Europe or the United States.

But Asia is another matter. The movement of Asian stocks often bears no resemblance to the movement of U.S. stocks — a condition that can smooth the ride of an investor who owns both. Compare Matthews Pacific Tiger (MAPTX), a typical regional fund, with Vanguard Index 500 (VFINX), the largest fund that mimics the U.S. benchmark, the Standard & Poor’s 500-stock index. In 1997, the Asia fund lost 41% while the U.S. fund gained 33%; in 1999, the Asia fund gained 83% while the U.S. fund rose only 21%; in 2001, the Asia fund gained 8% while the U.S. fund lost 12%.

Last year, the S&P 500 fell 22%, but Japan (in dollar terms) was down only 10%, and Malaysia, down 4%. Meanwhile, Korea was up 1%, Thailand up 23%, Indonesia 31% and India 7%.

Headley sees two good reasons to invest in Asian stocks. The first is that “you don’t know what the next five or 10 years will bring.” In other words, since the future is unknowable, you should make sensible investments all over the lot. You’ll have some winners and some losers but, overall and over time, if the world economy grows, then stock prices should rise smartly.

Headley finds it strange that many investors are obsessed with “slicing and dicing the [U.S.] equity market structure about 20 different ways — value and growth, small to large capitalization,” etc., etc. But “in international investing — i.e., the other 95% of humanity and the other 50% of [world] market capitalization — we put down the scalpel and pick up the sledgehammer.” That is, investors think they are getting diversification merely by putting, say, 10% of their portfolio into an international mutual fund — which often turns out to be a fund that puts the vast majority of its assets into European stocks.

If one-tenth of your portfolio is in an international fund and only one-quarter of that is in Asian stocks, then just 2.5% of your total assets are Asian. Is that enough? Headley doesn’t think so. Asian companies represent 15% of global market capitalization (that is, the value of all shares according to investors), and Asia produces 24% of the world’s GDP. Headley believes market cap is “a very skittish indicator,” and economic output is the basis for a more “sensible weighting.” Still, take the most pessimistic scenario for Asia and cut the GDP share in half. That means that roughly 12%, or about one-eighth, of your stock holdings should be Asian.

Raise your hand if you’re anywhere near that figure. (I didn’t.) If mere rational diversification doesn’t encourage you to go Asian, then consider Headley’s second reason: Asia, with an economy outstripping Europe’s and America’s, is the right place to be for the 21st century. China, the main engine of growth, is not merely making things and exporting them; it is buying things, too, from smaller Asian countries. Last fall, Taiwan’s exports to China rose by one-third. “Look out to a 10- or 15-year time horizon, and Asia clearly will be a richer, bigger place,” Headley says.

Yes, the collapse of 1997 devastated many Asian markets, but “they have been digging themselves out of the rubble,” he says. South Korea, notably, has changed its economic policies for the better. The country’s foreign-currency reserves hit $121 billion in December, a new record.

At the corporate level, says Headley, “Korean companies never used to care about the bottom line, but they have switched to the U.S. business model.” Returns on equity (that is, the rate of profit earned on the shareholders’ investment) have risen to around 15% in Asia — outside Japan, that is — but, meanwhile, valuations are cheap. Price-to-earnings (P/E) ratios average around 10, or less than half the current U.S. level.

“Corporate Asia has been working hard on its act,” says Headley, “and has not gotten credit for it.” That’s good news for investors — strong companies are being ignored.

Headley does not deny that Asia is risky. After all, the booming and sophisticated city of Seoul is just 40 miles from the crude, poverty-stricken, unpredictable garrison state of North Korea. You think the U.S. market is volatile! The Matthews Korea Fund (MAKOX), which Headley has managed for the past five years, doubled in value in 1999, then lost all those gains in 2000, then rose 71% in 2001 and continued its winning streak with an 8% return in 2002. (By the way, Matthews Korea, with an average annual return of 19.9%, had the third-best performance of all 4,169 funds tracked by Morningstar over the five years ending Feb. 12.) High volatility means high rewards. Certainly, high-risk sectors should not comprise your entire portfolio, but, for long-term investors, putting 10% to 15% into Asian stocks is not a wild and crazy thing to do.

Many Asian stocks — beyond the huge Japanese multinationals — are solid citizens. Samsung Electronics, which represents a whopping 24% of the assets of Fidelity Advisor Korea fund (FKRIX) and 11% of Matthews Korea, is a world-class company. At last report, Templeton Foreign (TFFAX), a broad international fund, has as its No. 1 asset Cheung Kong Holdings (CHEUY), a firm that owns real estate in Hong Kong and mainland China, plus interests in utilities, energy retail and in a popular Chinese-language Internet site, Tom.com. The Templeton fund, which has an excellent five-year performance record and below-average risk, has four other Hong Kong companies among its top 25 stocks, including CLP Holdings (CLPHY), one of Asia’s largest electric utilities, and Swire Pacific (SWRAY), which owns stakes in Cathay Pacific Airways and Dragonair, a regional Chinese carrier.

One of the biggest changes in Asia is the expansion of consumer credit. Koreans and Chinese are actually taking out mortgages to buy houses and apartments, and they’re using more credit cards. That’s one of the reasons the Matthews Pacific Tiger Fund has been investing heavily in financial stocks, including Korea’s Hana Bank, the fund’s biggest holding, and Kookmin Credit Card; Hong Kong’s Dah Sing Financial (DAHSF) and Bank of East Asia (BKEAY); and Thailand’s Bangkok Bank. Headley says he tries to balance his holdings of consumer retail stocks, financials and technology.

But if you want to invest in Asia, it’s folly to do it yourself, unless you want to buy giant Japanese auto and electronics stocks — such as Canon (CAJ), Sony (SNE) and Toyota Motor (TOYOF) — which appear more correlated to U.S. and European large-caps.

Instead, buy a good mutual fund. Morningstar bestows four stars on Matthews Pacific Tiger, which, through January, had scored average annual returns of 8% for the past five years — with above-average risk and a relatively high expense ratio of 1.9%. Another good choice, T. Rowe Price New Asia, hasn’t performed as well, losing an annual average of 0.6% for the past five years, but its risk levels and expenses are lower. Neither of these two funds, by the way, owns Japanese stocks.

For those, the top pick is probably Fidelity Japan (FJPNX), a four-star fund that has managed to eke out a profit for its investors over the past 10 years. The top holding is one of my favorite companies of any sort, Nissan Motor (NSANY).

Investing in China is tricky. The leader, by far, is Matthews China (MCHFX), which Headley manages with G. Paul Matthews and Richard Gao. The fund, with five stars from Morningstar, returned a total of 53% between 1999, its first full year, and 2002. Other good performers are Investec China & Hong Kong (ICHKX) and Fidelity China Region (FHKCX), both of which are dedicated almost exclusively to Hong Kong-based blue chips.

An intriguing selection — perhaps the best of all — that dampens the risk of Asian stocks by owning only dividend payers is Matthews Asian Growth and Income (MACSX), a five-star fund with exceptionally low volatility. The fund has produced positive returns in each of the past five years and in seven of the past eight (the exception, of course, was 1997). Average annual return since 1998: an incredible 15.6%. At the end of 2002, the fund, managed by Matthews himself, had 47% of its assets in stocks based in Hong Kong; 23% in South Korea; 9% in Thailand; and 8% each in Singapore and mainland China. Here too, however, there is no exposure to Japan. You’ll need a separate fund for that.

Headley figures that investors will not shun Asia for long. “Asia tends to attract money when the markets are hot,” he says. In other words, investors try to time their entry, and it’s almost always too late. “The tragedy of our lives,” he adds, full of rue, “is that people throw money at you after the stocks have already run up.”

— James K. Glassman is a fellow at the American Enterprise Institute and host of TechCentralStation.com. This column originally appeared in the Washington Post.

James K. Glassman, former Under Secretary of State for Public Diplomacy under President George W. Bush, is a member of the advisory board of the Infrastructure Bank for America, a proposed private institution to invest in U.S. infrastructure.


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