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SCMP Reporter

GLOBAL investors looking for markets with low correlations with major Western equity markets should eschew developing ones like Hong Kong in favour of less well-trodden investment trails, like Taiwan, says James Capel Asia.

  The finding is contained in its bulletin on strategic investment issues.

  In a new study of equity market correlation around the globe, the brokerage found that Asian equity correlations with global markets remained low.

  In the report, Chris Edwards said: 'Traditional regional markets [like Hong Kong, Singapore and Malaysia] provide little protection against global events, but less developed markets [such as Taiwan] do.'   The survey discovered there were trends in correlation.

  'During periods of volatility, Asian markets become highly correlated with global markets,' said Mr Edwards.

  Global trends were important factors during these times of volatility, for instance, the link between the United States dollar and the Hang Seng Index.

  Mr Edwards said: 'The response of markets around the region to the hike in the [US Federal Reserve] funds rate earlier this year highlighted the sensitivity of Asia to global market phenomena.'   Investors seeking low correlative markets need to find ways around this problem of high global volatility leading to high global market correlation, especially in Asia.

  Investors seeking insulation from global market correlation were facing the need to spread out.

  'For protection, these investors must move even farther afield to less-developed markets such as Indonesia, India, the Philippines, South Korea, Taiwan and Thailand,' said Mr Edwards.

  This is because portfolio diversification and risk spreading has provoked an unprecedented level of globalisation in investment management.

  This kind of diversification has benefited Asia tremendously, and for the investor it has provided a boost in returns while offering a lower level of risk.

  There are three exceptions: the October 1987 world stock market crash, the Gulf War and the rise in US interest rates in February.

  Going back even farther, high correlation was exhibited in the global recession of 1982 and amid the strong US dollar in 1984.

  'During periods of high correlation, market returns are similar, and country selection becomes less relevant,' said Mr Edwards.

  In these circumstance the question is whether to be in equity markets at all as opposed to which market in which country.

  The story behind the growing sensitivity of markets to global phenomena is a threefold saga.

  Increasing trade flows and international economic integration of regional economies makes them susceptible to flow-through effects from global economic events.

  The deregulation of economies, capital markets and investment restrictions increases the speed and ability in responding to market forces.

  'Globalisation of capital markets, especially with the US and Japanese liquidity flows under-pinning many international equity markets, sees increased sensitivity as these flows are often the first to reverse when global uncertainty increases,' said Mr Edwards.

  The table on correlation across indexes in the region shows how low different markets are correlated with the US and the less-developed markets in Asia have been less affected by events affecting the US.

   In this respect, wide diversification in the region provides a great spread of risk for investors solely interested in the Asia-Pacific region.

  Mr Edwards pointed out that the markets with low correlation with the US also showed low correlation with the three major markets in Asia - Hong Kong, Singapore and Malaysia - and could be used to diversify regional risk.

  The problem the investor faces going further afield is one of limited access to foreign investors.

  These can be statutory, and they can also be linked to problems of logistics associated with settlement, custody and custodianship.

   Some fund investors are denied access to these markets because their trustee terms preclude such investment on the ground of volatility, liquidity and problems of security of custody.



Take the road less travelled, James Capel tells investors