Market dictates a picky approach

IT'S ALMOST BECOMING a standard refrain from fund managers these days. They are telling investors to downsize their expectations and anticipate lower long-term returns from equities than those enjoyed in the roaring 1990s. With little or no inflation, low interest rates and stubbornly bearish sentiment, top-line growth faces strong headwinds, the experts argue, meaning profits will also be subdued. The best investors can hope for are returns in the 6-8 per cent range going forward, against the much higher numbers of the past decade. This may be true for the developed markets but investors in Asia may well be rewarded with strong outperformance, Richard Titherington, head of global emerging markets at JF Funds, says. 'I was asked by someone yesterday: 'Equity returns have been very good in the past decade, do you think they are going to be lower in the next decade?'' he said. 'I said: 'They haven't been very good in Asia in the past decade and I think the next decade will be better. I wouldn't necessarily say that about the US but I'm quite positive about the future for Asia.'' Take a look at a comparison of the United States benchmark S&P 500 Index versus the MSCI AC Asia-Pacific ex-Japan Index and you will see what Mr Titherington means. The S&P started the 1990s at 348 points and ended the decade at 1,469 points, giving a handsome annual return of 32 per cent. The MSCI Asian benchmark, meanwhile, started the decade at 151 points and ended it on 255 points giving an annual return of just 6.8 per cent. Then fast forward from the start of 2000 to today. The S&P has fallen to 869 points, giving back a lot of its gains but is still up 149 per cent since the start of 1990. The MSCI Asian benchmark has fared far worse falling all the way back to 157 points and losing virtually all of its gains. An investor who started tracking the MSCI Asian index in 1990 would today realise a miserly total return of 3.97 per cent. JF Funds likes to position itself as a stock-picking house with an eye for the long term. Its flagship Asia ex-Japan fund, JF Eastern, has been able to outperform the MSCI benchmark, producing a gain of 7 per cent for the past three years against a loss of 27.5 per cent by the index. Despite Asia's poor track record in the past decade, there are plenty of reasons to be upbeat about the region now, according to Mr Titherington. There is a reasonable economic backdrop as at least part of the region is now emerging from the painful deleveraging process that followed the Asian financial crisis in 1997-98. 'Many of the debt problems that the rest of the world has [experienced] we have been through and we have come out at the other side. The basic economic fundamentals are stronger,' Mr Titherington said. While export demand could slide, the effect was cyclical, he said. And Asia was being bolstered by a secular global move to outsource manufacturing to the region with profit margins of Western companies under severe pressure. 'Even our export industries will come through this difficult economic environment in relatively good shape because we are the low cost producer. In a tough economic environment the low-cost producer is the right place to be,' Mr Titherington said. Of particular interest to investors is how corporate fundamentals have improved since the Asian financial crisis. Net debt to equity ratios for regional non-financial companies have fallen to 35 per cent from nearly 60 per cent, while interest coverage has risen from three times in 1998 to nearly six times, according to figures marshalled by JF. Meanwhile, return on equity of Asian companies has improved to just below 10 per cent and the number for once-highly profitable US firms has fallen away from the high teens. 'The profitability of Asian companies is much improved. There was a period when particularly US companies were significantly more profitable. Their return on equity was about twice Asian companies were able to produce. Now that's about the same level,' Mr Titherington said. Using his favourite valuation method of price to book, Mr Titherington pointed out that Asia was on a ratio of 1.25 times versus more than two times for US firms. 'Asian equity markets are much cheaper than the rest of the world. Effectively now you can buy the same level of profitability as you can in the US at roughly half the price,' he said. 'I think people realise this is an attractive combination, this is what's driven outperformance for the past 18 months and I think it is a sustainable trend.' The price-to-book ratios Asian stocks were on now made them as cheap as they were at the depth of the financial crisis in 1998, said Mr Titherington. 'We are very close to the crisis lows in terms of valuation but we are now much stronger and in a much lower risk position. At this point at the bottom of the crisis . . . things were cheap but you could think that things were going to get a lot worse,' he said. 'Now you don't have the same risk that we had in places like Malaysia and Korea and Indonesia, you don't have the debt problem that we had then. The only problem that we have got in a macro sense is the exposure we have got to the US because of our export industries.' Many investors are starting out from the first principle of what will happen to the US economy. For JF this was the wrong way, said Mr Titherington. The house prefers to focus on stock picking rather than big top-down calls. 'I think it's important we don't base our Asian investment strategy on our economic forecast for the US economy. If the US economy recovers we will benefit from it but we are not betting our portfolios on that assumption,' he said. What the house was doing was 'trying to find companies around the region that offer high returns at an attractive price'. Among the types of firm it likes are Korean consumer product play LG Household, which boasts a 30 per cent return on equity trading on only eight times earnings, and Tong Ren Tang, an SAR-listed Chinese medicine company expected to grow annual earnings at 20 per cent but which trades on a PE of only 10. Richard Titherington 1984: Graduated from Oxford Uni versity then joined UKPI. 1986: Moved to Save & Prosper. 1988: Joined Fleming Investment Management. 1992: Moved to Hong Kong as a pension fund manager. 1994: Become Asia regional fund manager. 2001: Appointed managing direc tor of JPMorgan Fleming Asset Management and head of global emerging markets.