Fund managers likely to allocate more to Asia

Despite higher share price valuations, the regionÆs strong economies are a major attraction at a time when there is not much growth elsewhere in the world.
More money will come to Asia ex-Japan stock markets despite the already fast rising share price valuations. ThatÆs the bold prediction of Merrill Lynch strategists Mark Matthews and Willie Chan in Hong Kong, authors of a recent investment strategy report.

In that report, they wonder if fund managers now have ôitchy trigger fingersö after seeing the MSCI Asia ex-Japan indexÆs total 12-month return now in excess of 60%.

After all, on the past three occasions when Asian stock markets rose by that much in such a short period of time, subsequent returns were mediocre. There is concern that at any moment, foreign investors could flee these exotic markets for more familiar pastures, they note, adding that such was the experience during the Asian financial crisis.

But after considering the similarities with the run-up to the Asian financial crisis and the current period, they conclude that the differences pull more weight.

They note that foreign portfolio money left Asia during the crisis because the region had over-extended itself, with high debt-equity levels and high current account deficits. Since the turn of the decade, much has changed û free cash flow is twice what it was then, and debt-to-equity is a fraction of what it was. AsiaÆs current account balances, which were deteriorating in the ten years up until the crisis, are now exceptionally strong.

ôInstead of running from Asian stock markets at the first sign of trouble, foreign investors are likely to allocate even more money to them, making them more expensive in the process,ö they write.

One strong reason for investing in Asia, is its robust economies, especially China and India, they note. China and India are forecast to have the strongest growth û around 9-11% over the next few years, while the regional average is slightly above 6%. More importantly, those two economies are expanding at a time when there is not much growth elsewhere in the world. Merrill Lynch forecasts a 1.4% gross domestic product (GDP) growth for the US next year, 1.0% for Japan, and 2.3% for Europe.

Although China and India are both major drivers of growth in the region, the former is their preferred stock market, and for various reasons.

ChinaÆs stated goal is to merge 150 of its largest companies into 80 by the end of this decade, they note. Asset injections to date have been on very generous terms to the listed acquirers and they expect the approaching ones to be the same.

IndiaÆs free float of 103% is much larger than ChinaÆs 11% as a percentage of money supply. That means is less stock to satisfy a large pool of money supply in China.

Wealth is also more widespread in China. India's GDP per capita in 2007 of $1,010 is around 40% of China's $2,460.

They believe more foreign investors are still underweight in China, leaving room for growth, whereas more of them are already overweight in India.

With an Asia ex-Japan model portfolio, Merrill Lynch is overweight in Hong Kong, China, Singapore, Malaysia, the Philippines, and Pakistan. It is underweight in South Korea, Taiwan and Thailand while neutral in India, Indonesia and Australasia.
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