Although US equities rallied handsomely in 2009 and the domestic economy showed signs of recovery, the performance of China’s stocks and economy reinforced the promise of Asia’s emerging markets for global investors. Matthews International Capital Management is the largest Asia-only investment specialist in the US and has helped investors benefit from the continent’s long-term growth story since 1991. We sat down with Taizo Ishida, lead manager of Matthews Asia Pacific (MUTF:MPACX), to discuss opportunities in the Asia-Pacific region’s developed and developing markets.
Some Western commentators have suggested that dangerous bubbles lurk beneath China’s impressive economic growth. Others worry about inflation in the wake of the government’s stimulus efforts. What’s your take on these concerns?
I’m in Hong Kong right now and spent the week visiting Shanghai, Shenzhen and other Chinese cities. On this trip I realized that there’s definitely a bubble in the high-end housing sector. Luxury condominiums command huge prices in Shanghai and Beijing, as well as in the second-tier cities. Housing prices heated up in 2007 and 2008, only to take a breather in 2009. The recent run-up has surpassed the previous peak.
It’s easy to attribute this jump to the government’s massive stimulus program, which injected so much liquidity into the marketplace. There may be a degree of truth to this assessment, but the trend has genuine structural supports; people want to buy houses to live in.
China’s consumer price index, a gauge of inflation, was up 1.9 percent in December; I’d guess that figure will head higher over the next 12 months. Investors should assume that authorities will tighten monetary policy at some point. The markets appear to expect this eventuality, but I regard this correction as healthy--in fact, I’ve been waiting for a pullback for quite some time. Some stocks that I couldn’t buy over the last six months are returning to valuations that warrant a second look. Any correction in Chinese equities is exciting, especially for investors who look three to five years down the road.
Which sectors do you favor in China?
Although I just noted that China’s housing markets are heating up, that’s only one of the sectors on my radar. Real estate stocks may be undergoing a correction, but the group’s long-term fundamentals remain extraordinarily attractive. And there are so many real estate companies to choose from. One of our top holdings is China Vanke (Shanghai: 200002), one of the biggest real estate developers in the Shenzhen area and one of the best-managed names out there.
I also still like Ctrip.com International (NSDQ: CTRP), a leisure travel agent in China and one of our biggest positions. The stock trades at a hefty valuation these days but still offers plenty of long-term upside--the Chinese love to travel. More immediately, the company should benefit from the Shanghai 2010 Expo, which kicks off in May and should attract a lot of travelers from within and outside China.
In the near term, I’d be a bit more cautious on cyclical groups, especially the auto industry. Shares of car companies outperformed last year and are likely due for a break. At the same time, it’s a good sector to be in if you look three to five years ahead.
Health care names generally lagged in last year’s rally, but the long-term fundamentals are attractive. There’s also opportunity in telecom stocks; the sector underperformed throughout Asia, and valuations are cheap.
That being said, it was easy to pick stocks last year; if you bet on a sector, chances are that 80 percent of the names went up. This year selectivity will be the key to success. Investors should focus on identifying the best player in each sector; I’d steer clear of the second- or third-best names, unless there’s a huge valuation gap--an unlikely occurrence after last year’s rally.
Chinese equities were great last year but won’t produce 50 to 60 percent gains this year. I’m still overweight Chinese stocks, but I’m taking profits in some of last year’s highflying names and allocating the proceeds to other markets that offer more upside in the near term.
Which Asia-Pacific markets do you favor for 2010?
Believe it or not, I’m shifting some of that capital to Japanese equities. At the end of last year Japanese stocks accounted for 31.5 percent of our investable assets, but our benchmark [the MSCI Asia Pacific Index] has a 40.7 percent weighting. We plan to gradually increase our exposure to 40 percent.
Japan’s market has performed horribly for the past two years, though it appears to have bottomed and has rebounded strongly over the past few months. I expect this momentum to continue. I prefer companies with high free cash-flow yields relative to market capitalization or enterprise value; based on that metric, the Japanese market holds many opportunities for investors.
We’re keen on companies that are levered to the Asian growth story, not traditional exporters.
Business in Japan is undergoing a shift from West to East; last year Japan’s total exports to Asia surpassed exports to the US for the first time. Our favorite names are pursuing this shift aggressively and in smart ways. We’ve found some mid- and small-cap names that generate 40 to 50 percent of their revenue from Asia.
One trend I’ve noticed is that companies that do well in China often participate in joint ventures with or have close ties to Taiwanese firms. Taiwanese companies have a solid track record of penetrating the Chinese market, and their management teams speak Mandarin. For historical reasons, Taiwan and Japan also share similar cultures.
What are some examples of these and other cross-border collaborations?
Tingyi Holding Corp (Hong Kong: 0322) is a Chinese company that operates beverage and instant noodle businesses, but the management is Taiwanese. The company formed a strategic relationship with the Japanese firm Sanyo Foods, an alliance that has provided the Chinese noodle maker with a lot of know-how. Whereas Japan’s instant noodle industry is well-established, Tingyi offers more upside because of sheer sales volume and the efficiency of a recently opened factory in China. A longtime favorite of the Matthews Asia Funds, Tingyi’s shares soared last year--the secret is out on that stock.
Softbank Corp (Japan: 9984), a leading Japanese telecom, media and Internet company, is another example of this phenomenon and one of our top positions. The firm’s CEO Masayoshi Son boasts strong ties to China, and Softbank owns 30 percent of Alibaba Group, the parent company of Alibaba.com (Hong Kong: 1688) and Taobao.com. This stake provides the company with sizable exposure to some of the top Chinese Internet players, but it’s not on the balance sheet.
We also added a New Zealand firm after Haier Electronics Group (Hong Kong: 1169), one of China’s biggest appliance makers bought a 20 percent stake in the company. This investment could catapult the company from a regional player in its home market and Australia to a global brand over the next five years.
As you can see, where a company does its business is far more important than the country it calls home.
At the end of last year, financials accounted for 28.6 percent of the fund’s portfolio. What’s your take on the sector?
In addition to real estate companies in China, Hong Kong and Singapore, the portfolio also includes three banks: India’s HDFC Bank (NYSE: HDB), China Merchants Bank (Hong Kong: 3968) and PT Bank Rakyat Indonesia (Persero) (Indonesia: BBRI). Each of these core holdings boasts strong fundamentals, though the stocks will experience ups and downs.
These investments represent a bet on the Asian consumer and growing middle class. It’s not science--households need a mortgage, a car loan and credit cards. My strategy is to pick the sector’s top players. HDFC, for example, is India’s best bank and arguably Asia’s best-run financial institution.
What’s your advice for investors looking to tap the Asian growth story over the next several years?
Remember that the economic changes underway in China aren’t taking place uniformly--that’s what makes the market so exciting.
For example, there’s a huge gap between Beijing, Shanghai and other coastal cities and the second- or third-tier cities that are further inland. Whereas Shanghai resembles London or New York City, the scene is completely different when you fly an hour west. In the major coastal metropolises, you see cars from global auto companies; in the second- or third-tier cities the cars are made by local auto companies. The wage disparity between the two Chinas is huge, but there’s no question that the average wage will continue to rise.
Investors seeking to profit from China’s growing domestic demand should bear this in mind. I’d look at high-end consumer brands; as incomes rise, the Chinese are gravitating to high-end, luxury brands--just like the Japanese did over the past 20 to 30 years, though that trend seems to be abating. At the same time, investors should consider companies that produce affordable, mass-produced goods and consumer staples that are in demand.
Real estate is another area that should provide long-term growth. In China it’s not as culturally acceptable to rent; the emerging middle class is keen on buying properties.
Outside of China, the consumption story isn’t as exciting. But even developed economies such as Japan and South Korea lack certain services that predominate in the West. For example, those countries don’t have a profusion of asset-management companies along the lines of Goldman Sachs (NYSE: GS). Generally speaking, those firms are in Singapore and Hong Kong. Even in China, the big banks offer wealth management and are doing it quite well. This could be another growth area.
Disclosure: "No Positions"