BofA Merrill Extends Asia Winning Streak

Money has been pouring into emerging Asia — and sending asset prices soaring — as investors seek performance that can’t be found in many developed economies. In the first four months of the year, Philippine stocks surged 23.5 percent; Indonesian, 16.2 percent; and Vietnamese, 14.7 percent. During the same period the S&P 500 advanced 12 percent. The International Monetary Fund announced in late April that it was “very carefully” monitoring massive inflows into Asian equities, and the Washington-based economic association advised policymakers in the region to be on guard against overheating markets.

Sell-side analysts are keeping an eye on the situation too, but opinion is divided as to whether the rallies are indicative of bubbles in the making or a foundation for sustainable growth.

“Over the past six years, global bond funds have seen inflows of $1.4 trillion, while global equity funds have seen redemptions of $900 billion — so there is a fair amount of catching up to do,” observes Stephen Haggerty, who directs Asia-Pacific equity research at Bank of America Merrill Lynch in Hong Kong. “Equity trading volumes actually remain depressed, so we remain optimistic about the potential for equity markets in the region.”

Ernest Fong, Haggerty’s counterpart at Credit Suisse, is similarly upbeat. “Fund flows have improved in the last six months, which is encouraging,” he contends. “Couple that with better-than-expected corporate earnings year-to-date and potentially some reallocation of assets into equities, and we are positive about the trend for the rest of the year.”

But Damien Horth, who oversees Asia and Japan equity coverage at UBS, strikes a more cautious tone. Although “not explicitly concerned about inflows into Asian equities,” he and his strategists are becoming less optimistic. “The region has chosen to rely heavily on low real interest rates and rising debt to offset weak external demand, very much as we expected,” notes Horth, who divides his time between Hong Kong and Tokyo. “The problem with credit-led growth is that much of the early gains in growth and asset inflation are normally given back later. Real interest rates have collapsed across the region and remain very low even today.”

Some markets could be setting themselves up for a fall, he adds. “Low real rates have been a source of optimism in the sense that we always believed Asia could put a high floor under growth with easy credit policies, and we thought asset prices would rise as a result,” Horth explains. “But it’s also a source of cynicism because it hasn’t been complemented with restructuring and liberalization. That means some of today’s prosperity has been borrowed from the future. We view this as an old-fashioned monetary theme — and it’s getting late in the day.”

These countries could maintain this course without enduring a crisis, “but that misses the point,” he says. “Several economies are vulnerable to even moderate rises in U.S. rates, and there are widespread signs of diminishing marginal benefits from rising leverage.”

With the global financial crisis still casting a long shadow, investors are understandably skittish about sustaining further losses to their portfolios. They rely on the acumen of sell-side analysts to help them determine when to get into a market — and when to rush for the exits. For a third year running, money managers say the researchers at BofA Merrill provide the insights they find most constructive. The firm captures 33 positions on Institutional Investor’s All-Asia Research Team, two fewer than last year, and is home to more than twice the number of teams considered the best in their respective sectors — 16 — than any other bank. Credit Suisse catapults from seventh place to second after adding six spots, bringing its total to 28. Morgan Stanley and UBS, with 27 positions each, share the third tier; the former jumps from No. 6 after picking up one slot, and the latter climbs from No. 4 despite losing one. Rounding out the top five is Deutsche Bank, which slips one notch after its total falls by two, to 26. These results reflect the opinions of some 3,140 investment professionals at more than 980 institutions managing an estimated $1.61 trillion in non-Japanese Asian equities. 

  The 20-Year Leaders

This year marks the 20th anniversary of the All-Asia Research Team survey. To commemorate this milestone, we aggregated two decades’ worth of results to determine which firms have captured the highest number of team positions since 1994. UBS is the big winner, with 407 appearances, including 81 sector-topping squads. J.P. Morgan claims the No. 2 spot, winning 385 total and 73 first-place positions. BofA Merrill, in third overall, has the same number of top-ranked teams among the 329 slots it captures. In fourth and fifth place, respectively, are Credit Suisse (288 positions, including 39 No. 1 teams) and CLSA Asia-Pacific Markets (274 and 47, respectively).

  The 20-Year Weighted Results

As interest in Asia has intensified, so has the shift away from thematic research and toward fundamental analysis, research directors report. “The focus of investors has returned to stock picking,” declares UBS’s Horth. This transition has been accelerated by a material performance divergence between North Asia (ex-Japan) and member countries of the Association of Southeast Asian Nations, he adds. “Also, many high-quality stocks are now trading at high valuations in a historical context, which makes it is very difficult for investors to find growth at a reasonable price anywhere in the region. We expect investors to remain highly focused on bottom-up ideas.”

Haggerty, of BofA Merrill, agrees. “Equity market correlations have started to normalize against the backdrop of an improving macroeconomic outlook,” he says. “In fact, stock-to-stock correlations globally recently fell to a seven-year low, which is undeniably good news for stock pickers and active management.”

Read more in the June international edition of Institutional Investor.