Asian markets maturing slowly

Investors looking to make a quick buck in Asia may very well reach that goal, but the developing economies of the region should really be considered as a long-term opportunity, according to managers who specialize in that part of the world.

The Asia-Pacific region is still largely seen as risky and extremely volatile by outside investors, but that volatility can be laid squarely at the feet of those same foreign investors, says K.C. Lee, portfolio manager of Fidelity AsiaStar fund.

“Foreign demand for Asian equities has been volatile,” Lee says. “There have been two spikes in 1993 and 1996, followed by long quiet periods. In the last two years, foreign demand returned in a big way.”

Another common misconception, Lee says, is that the Asian economies move in tandem. Over the longer term, correlation between the Asian markets is quite low, he says, aside from any large moves, which usually affect the global market anyway.

He says while Asian markets are still regarded as having a high risk profile, foreign investors’ risk appetite has surged and remained strong over the past two years. He also suggests that some markets have been overbought in technical terms, with companies struggling to put capital to efficient use as quickly as it flowed in.

What the continent needs now, is increased investment from its own people.

“I expect domestic investors to play an increasing role in domestic markets,” Lee says. “Equity ownership is generally quite low in Asia.”

Korea is the most transparent on the issue of equity ownership among the Asia Ex-Japan markets. Despite being the most developed economy in the group, investors hold only about 5% of their savings in equities, compared to 11% in Japan.

Lee expects Korean investors to eventually reach the same level of equity market participation as their Japanese counterparts, which will stabilize the market considerably, due to the near-universality of home-market bias.

Koreans are not alone in their slow adoption of equity investing.

“The Chinese have a high saving rate near 50%,” says Tim Leung, Head of Asian Equities for Investors Group Investment Management in Hong Kong and Portfolio Manager of Investors Pacific International Fund.

“The banking system has total individual saving deposits of $2 trillion US that earn just 0.75%-2.07% return per annum. Nonetheless, the ratio of stock market capitalization to GDP is relatively low level of 30%.”

To encourage greater domestic participation, many of Asia’s central banks have embarked on policies which discourage savings.

“Most of the central banks in Asia have abandoned the fixed exchange rate policy, opting for more flexibility,” says Lee. “The flexible exchange rate policy allows these central banks to have more autonomy on interest rates.”

The result has been relative stability in rates across much of the continent, with rates largely declining in real terms. With lower interest rates on fixed income vehicles, investors have taken a new interest in equity investing.

Interestingly, Lee says central banks have also been encouraging businesses to seek financing through equity issuance, which they have done despite the lower interest rates. This has also allowed businesses to clean up their balance sheets.

Central bank monetary policy in the greater Asia-Pacific region is also the source of some anxiety abroad.

One of the big questions regarding Asia is the end of the Bank of Japan’s zero interest rate policy (ZIRP). On Friday, the bank raised its overnight lending rate to 0.25%, the first increase in six years. There has been some speculation on what impact higher Japanese interest rates would have on the global economy, as it could signal the end of the yen carry trade.

Some money managers have taken advantage of the “free money” they could borrow in Japan, borrowing to invest in U.S. Treasury bonds to capture the difference between the bond’s coupon and the near-zero interest on the loan. Some market watchers fear that an end to ZIRP will send these investors scrambling to unwind their positions, selling off the Treasuries and driving down the U.S. dollar in the process.

But Lee says the value of the carry trade is likely overestimated and that the Bank of Japan can raise interest rates without triggering a global meltdown in account balances.

Shifting attitudes

While domestic investment is yet to take off, consumption has been catching on in a big way. Not only has the government of China recognized that domestic consumption can help drive growth, but it is also encouraging consumerism as a means to reduce its trade deficit.

Most countries would relish such a burden, as China’s trade surplus exceeded $100 billion in 2005 and is expected to repeat that performance for 2006. But with that massive inflow of cash has come calls from trading partners – and none more loudly than the U.S. – for Beijing to allow its currency to appreciate on the global exchange markets.

With the renminbi artificially low, neither manager hedges against its fluctuations, saying that would remove a significant opportunity for additional returns.

“China is accumulating significant trade surplus and experiencing strong capital inflows, the pressure on the Chinese currency Renminbi long term is on the upside, even against Canadian dollar,” says Leung.