Asian Fund Managers Counter Volatility by Focusing on Long Term

“Volatility” isn’t just a buzzword in Asia. Just look at what’s happening on the ground.

The vaunted Chinese economy is slowing down, squeezing company earnings and stock prices. Japan is making a comeback of uncertain degree under the stimulative policies of Prime Minister Shinzo Abe. Meanwhile, hints of a withdrawal from quantitative easing policies by the U.S. Federal Reserve are threatening to tighten liquidity across Asia, roiling capital markets. India and Indonesia have raised interest rates recently in a bid to defend their currencies.

These trends pose a number of challenges to fund managers in a region that claims about two thirds of the world’s emerging-markets assets. The economic currents from China and the U.S. “have combined to create a period of intense uncertainty in markets,” says Andrew Swan, head of Asian fundamental equities with BlackRock Asset Management. But “this does not mean there are no opportunities for investors in China,” he adds, and “a stronger U.S. would be beneficial for Asian exporters such as Korea and Taiwan.”

China, the world’s second-largest economy, has been slowing since 2011, with the International Monetary Fund recently lowering its growth forecast for this year to 7.8 percent. Stocks also remain mired in a bear market: The CSI 300 Index was trading nearly 38 percent below its 2009 peak at the start of September. Yet managers can’t ignore the market of the region’s largest and most dynamic economy.

“Slowdown is inevitable, but I’m not sure it will have a great impact on asset management save for in China itself,” says Hugh Young, managing director of Aberdeen Asset Management Asia, in Singapore. “Given the speculative nature of Chinese equity markets, a slowdown might lead to reflection on what asset management should be — longer term, more fundamental, or so we would argue.”

Aberdeen’s strategy is to focus on bottom-up stock picking. That can be inglorious work, as China’s A-share market has fallen by 6.7 percent this year as of September 3 and Hong Kong–listed H shares of mainland Chinese firms were down 10.5 percent. “For the equity market to perform, fundamentally we need to see macro and corporate earnings improvement to support valuation expansion,” says Yutaka Itabashi, head of international business with Nomura Asset Management in Tokyo.

Hunter Hall, a Sydney-based manager of ethical funds, decided to reduce its China exposure after chief executive Roland Winn visited the country twice in 2011 and decided that the economy was overheating. The firm reduced China’s weighting in its international funds to less than 10 percent from a figure in the teens previously. “China is still a very difficult market to invest in due to the level of noise,” says Winn. “Things are cheap, but why? We have been heavily invested in China in the past and, fortunately, lighted up at the right time.”

But stock picking in China has its logic. Chinese Internet, technology and travel-related shares are attractive because they lead the country’s new economy, says BlackRock’s Swan, and medical firms show long-term promise because of increased healthcare spending.

BlackRock is still building capacity in Chinese equities. The New York–based firm received a second qualified foreign institutional investor (QFII) allocation of $100 million in March, says Swan.

In July the Chinese government announced that it would increase its overall QFII quota to $150 billion from $80 billion, which could portend a big increase in foreign investment. “This will help the A shares in the medium term, in terms of liquidity,” says Nomura’s Itabashi. “We are monitoring the development of market changes closely.”

The country’s giant insurance companies have also received attention since January, when the government began letting them invest up to 15 percent of their assets overseas to increase returns, notes Anthony Fasso, chief executive for international operations with AMP Capital of Australia.

As China slows, Japan shows tentative signs of economic rebound after years of stagnation. Since taking power in December 2012, Abe has talked down the value of the yen, introduced a fiscal stimulus program and prodded the Bank of Japan to launch a major quantitative easing program. Those initiatives have tickled the stock market, although doubts about their efficacy have caused prices to retreat from their highs. The Nikkei 225 Index was up 34.5 percent year to date as of September 2.

Hunter Hall is overweight Japanese equities, as share prices were cheap last year and should gain value if people now holding cash and bonds begin switching into stocks, says Winn. But like other investors, he questions how well Abenomics will work and wants to see tangible gains. “We really need to see Japanese investment and a GDP kick-start for this to be a sustained positive development,” he says.

Asian fund managers are also keeping a very close eye on the Federal Reserve. Analysts at Nomura Asset Management estimate that about 10 percent of the Fed’s bond purchases under quantitative easing, or roughly $200 billion, have ended up leaking into the Asian market. A reduction in QE would reduce liquidity in Asia markets, fund managers note. On the other hand, any decline in Asian currencies as a result of U.S. tightening should give a boost to Asian exporters — and their stock prices.

The prospect of higher U.S. interest rates has hit India. Concerns about the government’s commitment to economic reform have also contributed to the slide in India markets and the rupee. Partly as a result, Reliance Capital Asset Management, one of the country’s leading fund managers, is hedging its bets.

India should see inflows of foreign capital into its stock market this year because of improved growth, says Sundeep Sikka, president and CEO of Reliance Capital in Mumbai. The IMF predicts that India’s growth rate will pick up to 5.7 percent this year from 4 percent in 2012. Yet Sikka says it’s not clear when inflows will turn positive, so Reliance Capital is maintaining a 25 percent allocation to Indian stocks, worth a total of $6 billion. “From an Indian perspective it’s still too early days,” Sikka says. Meanwhile, Reliance Capital plans to open an India fund in Japan and a Japan fund in India, building on signs of progress for both economies.

Elsewhere, fixed-income assets may also lose their shine as interest rates rise in reaction to U.S. policy, so Asian investors are shifting to alternatives such as real estate, infrastructure and hedge funds, says Jason Yu, managing director in the Hong Kong office of Samsung Asset Management. Nowhere is the trend clearer than in Samsung’s home country, South Korea. The government began allowing hedge fund investment in 2011, and Yu’s firm has moved quickly to grab a 23 percent share of the market, worth 338.5 billion won ($304 million). “Recently, there is a growing demand for alternative investments in Asia, both from institutions and retail, and we expect the trend to continue,” he says.

Even so, passive is still the name of the game in South Korea. Exchange-traded funds held 14.7 trillion won in assets last year, fully 49 times larger than a decade earlier. Samsung, the biggest ETF provider, with 55 percent of the market last year, expects the popularity of this investment class to grow elsewhere in Asia. So in 2007 it listed its Kodex 200 fund, which aims to track returns of Seoul’s Kospi 200 stock index, on the Tokyo Stock Exchange. It followed that earlier this year by listing in Tokyo the Samsung Group ETF, which seeks to track the performance of companies under the Samsung umbrella. “Samsung is broadening its scope of markets and products to become a leading player in the region,” Yu says. • •