Aberdeen says markets undergoing necessary purging
Investment Outlook Series: Hugh Young, head of equities at Aberdeen Asset Management Asia, says an economic slowdown will weed out companies that have been expanding recklessly.
This is part of an AsianInvestor series on the investment outlook of fund managers with Asian portfolios.
Hugh Young is a Singapore-based managing director at Aberdeen Asset Management Asia, Aberdeen Group's regional headquarters in the region. He is group head of equities as well as a member of the executive committee responsible for the Aberdeen Group's day-to-day operations. He co-founded AberdeenÆs Singapore office in Asia in 1992, having been recruited in 1985 to manage Asian equities from London. Since then, he has built the company into one of the largest managers of such assets globally.
AberdeenÆs Singapore office manages around $38 billion in regional assets. Investments are run on a team basis, with the 14-strong regional equity team based in Singapore overseeing local teams in Bangkok, Kuala Lumpur, Sydney, Hong Kong, and Tokyo. These local teams provide stock research and ideas to the regional team as well as manage domestic funds.
Aberdeen Group manages around $230 billion worldwide, including around $48 billion in Asia.
What are the biggest opportunities that you see in the markets you are responsible for in the coming 12 months? How are you preparing to take advantage of those opportunities?
Young: The main opportunities are of equities becoming oversold because of heightened risk aversion. This trend has been evident in declining share prices and heightened volatility over the past several months. However, bargains are not yet in widespread evidence. Earnings are at risk from margin squeeze as higher inflation hits both costs and demand.
We don't have a pre-determined view as to where the best opportunities will emerge. Financials have suffered collateral damage from the credit crunch û yet in Asia there is little evidence of exposure to the more toxic mortgage-backed securities. Utilities and sectors that enjoy monopoly-like rents are also well-placed. But one has to be careful in regulated sectors because tariff structures can be out of step with producer costs.
As stock pickers, we just aim to keep a very close eye on what is happening in our portfolio. We think that our holdings are very well placed to weather the current environment, if not to thrive in it. Indeed, we think that the slowdown will serve to precipitate weaknesses at those numerous companies which have been expanding recklessly, particularly those that have done so with borrowed money. This may in fact provide many of our holdings with opportunities to pick up assets cheaply.
How different or similar is your 12-month investment outlook now compared to the start of this year?
We were sceptical of the reasons for last year's rally, and the increasingly narrow strata of stocks on which it was based foreshadowed a market reverse sooner or later. While we can't claim to have predicted the extent to which markets have unwound since October, we haven't had to change our positions much since. Our view now as then, broadly, is that markets were overbought and what we are seeing now is a necessary purge. How long this lasts is an open guess. There are obvious imbalances in the global economy, and it is not yet clear what the cost of redressing them will be.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
No
What are your favoured markets in Asia?
We're not top-down investors, so we don't look to invest on the basis of macro developments. We like Singapore for the quality of its companies, regulatory standards and overall transparency. We also see value in India, where companies are well-run, conservative and give confidence that they can prosper despite inflationary headwinds and government inertia. But there is a danger of over-generalising and there are plenty of good companies elsewhere.
What are the markets you are going to steer clear of in the coming year?
We don't consciously favour or avoid countries because the country decision is passive. But historically we've found poor management accountability and weak governance a problem in Korea and Taiwan, in particular. The latter is over-exposed to technology and is very margin-sensitive, being largely a commoditised OEM industry. Falling demand has thus hit the sector hard.
What are your market weightings within an Asia ex-Japan equities portfolio?
Australia: 9.1%
China: 4.9%
Hong Kong: 20.5%
India: 13.2%
Indonesia: 1.2%
Korea: 10.8%
Malaysia: 4.8%
New Zealand: 0
Pakistan: 0
Philippines: 2.0%
Singapore: 21.0%
Sri Lanka: 0.8%
Taiwan: 6.6%
Thailand: 4.7%
Vietnam: 0
Cash: 0.4%
Which sectors do you expect to outperform in the coming year?
We expect defensive sectors to outperform, but those that have pricing power and whose selling prices are not subject to government approval. This would include selected utilities and consumer staples. We also think that, despite the problems facing the global financial sector, regional banks should do well over the next year. Their balance sheets are generally in very good shape and although non-performing loans may rise, banks are often able to pass on at least part of this rising cost.
Which sectors do you expect to underperform?
It is apparent that Asia has not decoupled from growth in developed markets, which we expect to slow more than expected. Consequently, we would expect export-related sectors such as petrochemicals and electronics to underperform.
What are the main challenges that you expect to face in the coming 12 months?
The main challenges are likely to come from clients. They may worry that Asia is vulnerable to the economic downturn and that recent stock market returns are not sustainable in the long run. If so, more money may flow out, even if Asian growth holds up relatively well, which we believe it will.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
The main risks are of slowing growth at a time of rising cost-push inflation. Governments are reluctant to address this by raising interest rates, for fear of causing growth to choke. On the other hand, if inflationary expectations feed into wages, prices will be much harder to tame later. The hope is that consumers respond to higher prices, resulting in growth slowing naturally. Such a slowdown could simultaneously be boosted by more public spending. But it is hard to see any weakness in the oil price lasting long and the widespread use of subsidies is putting fiscal balances under pressure.
How these headline risks affect companies will differ. A lot comes down to pricing power, how well balance sheets are managed and the dynamics of demand. For example, companies that have won fixed price building tenders could be hurt by rising materials costs. We will manage the risks the same way we always do, by making sure our portfolios are well diversified and keeping abreast of developments at our holdings.
Hugh Young is a Singapore-based managing director at Aberdeen Asset Management Asia, Aberdeen Group's regional headquarters in the region. He is group head of equities as well as a member of the executive committee responsible for the Aberdeen Group's day-to-day operations. He co-founded AberdeenÆs Singapore office in Asia in 1992, having been recruited in 1985 to manage Asian equities from London. Since then, he has built the company into one of the largest managers of such assets globally.
AberdeenÆs Singapore office manages around $38 billion in regional assets. Investments are run on a team basis, with the 14-strong regional equity team based in Singapore overseeing local teams in Bangkok, Kuala Lumpur, Sydney, Hong Kong, and Tokyo. These local teams provide stock research and ideas to the regional team as well as manage domestic funds.
Aberdeen Group manages around $230 billion worldwide, including around $48 billion in Asia.
What are the biggest opportunities that you see in the markets you are responsible for in the coming 12 months? How are you preparing to take advantage of those opportunities?
Young: The main opportunities are of equities becoming oversold because of heightened risk aversion. This trend has been evident in declining share prices and heightened volatility over the past several months. However, bargains are not yet in widespread evidence. Earnings are at risk from margin squeeze as higher inflation hits both costs and demand.
We don't have a pre-determined view as to where the best opportunities will emerge. Financials have suffered collateral damage from the credit crunch û yet in Asia there is little evidence of exposure to the more toxic mortgage-backed securities. Utilities and sectors that enjoy monopoly-like rents are also well-placed. But one has to be careful in regulated sectors because tariff structures can be out of step with producer costs.
As stock pickers, we just aim to keep a very close eye on what is happening in our portfolio. We think that our holdings are very well placed to weather the current environment, if not to thrive in it. Indeed, we think that the slowdown will serve to precipitate weaknesses at those numerous companies which have been expanding recklessly, particularly those that have done so with borrowed money. This may in fact provide many of our holdings with opportunities to pick up assets cheaply.
How different or similar is your 12-month investment outlook now compared to the start of this year?
We were sceptical of the reasons for last year's rally, and the increasingly narrow strata of stocks on which it was based foreshadowed a market reverse sooner or later. While we can't claim to have predicted the extent to which markets have unwound since October, we haven't had to change our positions much since. Our view now as then, broadly, is that markets were overbought and what we are seeing now is a necessary purge. How long this lasts is an open guess. There are obvious imbalances in the global economy, and it is not yet clear what the cost of redressing them will be.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
No
What are your favoured markets in Asia?
We're not top-down investors, so we don't look to invest on the basis of macro developments. We like Singapore for the quality of its companies, regulatory standards and overall transparency. We also see value in India, where companies are well-run, conservative and give confidence that they can prosper despite inflationary headwinds and government inertia. But there is a danger of over-generalising and there are plenty of good companies elsewhere.
What are the markets you are going to steer clear of in the coming year?
We don't consciously favour or avoid countries because the country decision is passive. But historically we've found poor management accountability and weak governance a problem in Korea and Taiwan, in particular. The latter is over-exposed to technology and is very margin-sensitive, being largely a commoditised OEM industry. Falling demand has thus hit the sector hard.
What are your market weightings within an Asia ex-Japan equities portfolio?
Australia: 9.1%
China: 4.9%
Hong Kong: 20.5%
India: 13.2%
Indonesia: 1.2%
Korea: 10.8%
Malaysia: 4.8%
New Zealand: 0
Pakistan: 0
Philippines: 2.0%
Singapore: 21.0%
Sri Lanka: 0.8%
Taiwan: 6.6%
Thailand: 4.7%
Vietnam: 0
Cash: 0.4%
Which sectors do you expect to outperform in the coming year?
We expect defensive sectors to outperform, but those that have pricing power and whose selling prices are not subject to government approval. This would include selected utilities and consumer staples. We also think that, despite the problems facing the global financial sector, regional banks should do well over the next year. Their balance sheets are generally in very good shape and although non-performing loans may rise, banks are often able to pass on at least part of this rising cost.
Which sectors do you expect to underperform?
It is apparent that Asia has not decoupled from growth in developed markets, which we expect to slow more than expected. Consequently, we would expect export-related sectors such as petrochemicals and electronics to underperform.
What are the main challenges that you expect to face in the coming 12 months?
The main challenges are likely to come from clients. They may worry that Asia is vulnerable to the economic downturn and that recent stock market returns are not sustainable in the long run. If so, more money may flow out, even if Asian growth holds up relatively well, which we believe it will.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
The main risks are of slowing growth at a time of rising cost-push inflation. Governments are reluctant to address this by raising interest rates, for fear of causing growth to choke. On the other hand, if inflationary expectations feed into wages, prices will be much harder to tame later. The hope is that consumers respond to higher prices, resulting in growth slowing naturally. Such a slowdown could simultaneously be boosted by more public spending. But it is hard to see any weakness in the oil price lasting long and the widespread use of subsidies is putting fiscal balances under pressure.
How these headline risks affect companies will differ. A lot comes down to pricing power, how well balance sheets are managed and the dynamics of demand. For example, companies that have won fixed price building tenders could be hurt by rising materials costs. We will manage the risks the same way we always do, by making sure our portfolios are well diversified and keeping abreast of developments at our holdings.
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