The Malay Dilemma: Is Malaysia A Safe Emerging Market Investment?

| About: iShares MSCI (EWM)

When most western investors think of Malaysia, they probably think of the Petronas Towers, the somewhat notorious trials of opposition leader Anwar bin Ibrahim or controversial former Prime Minister Mahathir bin Mohamad rather than "The Malay Dilemma," the latter's equally controversial book that helped to set the country's course for the past 40 years or so. It also doesn't help that the iShares MSCI Malaysia Index Fund ETF (NYSEARCA:EWM) is really the only easy way for western investors to gain exposure to Malaysia - arguably Southeast Asia's forgotten emerging market because it's largely overshadowed by its neighbors.

However, Malaysia is one emerging market that will soon be on the radar of western media again this year because Barisan Nasional, the coalition of political parties that's been in power for 54+ years, must hold elections by the end of June, and the country's large Chinese and Indian minorities along with some Malays are increasingly restive for change. And depending upon what happens in those upcoming elections, there could be a buying or trading opportunity for the iShares MSCI Malaysia Index Fund ETF.

But first, investors need to take the time to understand the history of Malaysia, the so-called Malay dilemma and the country's rather complicated politics which are based around race, religion (Islam) and affirmative action programs for the so-called Bumiputera or Bumiputra ("son of earth" or "son of the soil") majority.

Understanding the Malay Dilemma

The Chinese and Indians had been coming to what would become the countries of Malaysia, Singapore and Brunei for centuries, but it was the British who brought in large numbers of Chinese and Indian coolies to work their plantations and mines during colonial times. By 2010, Muslim Malays accounted for about 60.3% of Malaysia's total population of around 29 million while the Chinese accounted for 22.9% and the Indians 7.1%.

(Source: Wikipedia)

When the British began pulling out of the region in the late 1950s at the height of the Cold War, they had largely wrapped up fighting the Malayan Emergency against communist guerrillas who were mostly ethnic Chinese. So they made sure that at least politically, the Malays were left in charge (something that became more assured when Chinese majority Singapore was kicked out of the Malay Federation in the 1960s), but simmering ethnic tensions between Malays and Chinese would culminate in the May 13 race riots in 1969.

The following year, Malay politician Mahathir bin Mohamad (who is actually part Indian) wrote a controversial book entitled The Malay Dilemma. If you have heard of Mahathir bin Mohamad, it might be because of his controversial comments about Jews that landed him bad publicity in Western media some years ago, but he ruled as prime minister of Malaysia from 1983 to 2003. The premise behind The Malay Dilemma and later affirmative action policies (known as the Malaysian New Economic Policy) for Bumiputera (Note: There is some debate over who actually constitutes a "Bumiputera" as the definition can be rather broad or narrow depending upon who is doing the defining) is this:

  1. The Malay race is the indigenous people of Malaysia.
  2. The sole national language is the Malay language and all other races need to learn how to speak and write in it.
  3. The tolerance and non-confrontational nature of the Malays has allowed them to be subjugated in their own land by other more "aggressive" races (as in the Chinese and the Indians) with the collusion of the British.
  4. An affirmative action program is needed to correct Malaysian Chinese hegemony in business.

I have been visiting Malaysia off and on for more than a decade and I was first introduced to Malaysia's Bumiputera affirmative action policies some years ago when a Malaysian Chinese friend told me how his parent's construction and engineering business is (on paper) majority owned or controlled or has a big percentage owned by Bumiputera, how roughly one-third of the employees are Bumiputera (as required by law) and how the highest "ranking" official or title holder in the company is a Bumiputera.

And what's the sole job of this highest "ranking" Bumiputera title holder in my friend's family business? It's to occasionally go the company's office to sign blank checks. When he is done signing the blank checks, his parents don't need him around - until they run out of blank checks and then they just call him to come back to sign some more.The Petronas Towers

It should also be mentioned that those classified as Bumiputera also receive all sorts of preferences in hiring for government jobs or to study at government funded universities (along with scholarships to do so); discounts on cars from the national car company Proton (and apparently lower import duties on foreign cars); discounts on real estate or mortgages (regardless of income level or the value of the property); and government contracts need to go to Bumiputera "controlled" companies that also receive subsidies and no doubt tax breaks. In fact, the term "Ali Baba" has been coined to describe people like the check signer at my friend's family business with the "Ali" referring to the Bumiputera who gets paid by the "Baba" or the Chinese - usually to get a government contract or to comply with other Bumiputera requirements.

This may not sound that much different from some of our own affirmative action policies in the States (or for that matter, in India or South Africa) and obviously they have created plenty of work for accountants and lawyers (as the rules have changed or grown more complicated through the years) along with bureaucrats and so-called "Ali Babas," but it has also made the Malaysian economy less efficient, government infrastructure projects more expensive and the non-Bumiputera increasingly resentful. For example: Another Malaysian Chinese friend once said to me that everyone plays together as children, but its only when you go off to university do you realize "how unfair things are and that's when we all separate into our own ethnic groups…."

However, it's not like the non-Bumiputera or rather the Malaysian Chinese in particular are suffering under the yoke of Bumiputera economic oppression as many know how to work under the system and make it work for them. On Forbes' 2012 Malaysia's 40 Richest list (which does not include any local sultans), only one person in the top 10 is not of Chinese or Indian descent (and he apparently has mostly Arab ancestry) and most of the 40 names appear to be Malaysian Chinese or Malaysian Indian names. Malaysian Chinese along with Malaysian Indians to a lesser extent continue to dominate the country's entrepreneurial and professional classes (or at least most professions, sectors and professional/managerial jobs with MNCs) plus official government statistics usually show that the average Malaysian Chinese is still wealthier than the average Bumiputera.The Petronas Towers at night

Nevertheless, the current system has led to a steady drip of educated Malaysian Chinese professionals moving to Singapore to build up the Singaporean economy (Singapore makes it easy for Malaysian Chinese to get employment passes and they are much more preferred than Mainland Chinese). And since most Malaysian Chinese have retained their Chinese culture and are usually fluent in at least English, Mandarin, Cantonese and a couple of other Chinese dialects, many have found employment as managers or professionals in China where they help to fuel that country's economic growth.

And Malaysia's Bumiputera? While the affirmative action policies have no doubt helped to lift many out of rural poverty and have created an urban and educated Bumiputera middle class (along with an elite), a mainland Chinese friend of mine who is attending graduate school at a government university in Malaysia (because it's cheaper than studying in the West) made the observation to me that the Bumiputera will show up to class to do and turn in their work, but that's about it (e.g. He was doing a special non-mandatory workshop and most of the students in it were other foreigners while 70%+ of the students in a normal class would be Bumiputera). After all and with most slots in government universities, most government jobs and a chunk of the jobs in local companies or government controlled ones set aside for them, there is little incentive for many to make any extra effort in school.

On the other hand, the Malaysian Chinese work extra hard in order to study at private universities either at home (at least three Australian universities, among other international schools, now have campuses in Kuala Lumpur alone) or abroad, they work one job and have a couple of freelance jobs or side businesses (where they get paid in cash), they do business in cash and they find "creative" ways to work the system with an "Ali Baba." In other words and baring a large population exit, their continued dominance of Malaysia's professional and entrepreneurial classes is largely assured.

The Malay Dilemma and the Upcoming Elections

That brings me back to the upcoming elections that may decide the future of Malaysia for generations to come and impact the iShares MSCI Malaysia Index Fund ETF. Since Independence in 1957, Malaysia has effectively been ruled by one party or rather a coalition of parties that today is known as the Barisan Nasional and consists of the United Malays National Organization (UMNO), the Malaysian Chinese Association (MCA), the Malaysian Indian Congress (MIC) and several small political parties mostly from East Malaysia (the states of Sabah and Sarawak on the island of Borneo). Barisan Nasional has effectively maintained a two-thirds majority in Parliament from 1969 until the Malaysian general election, 2008 when opposition parties won 82 seats (out of 222 seats) or 36.9% of parliamentary seats (with the remaining 140 seats or 63.1% going to Barisan Nasional).

Composition of Malaysian 13th Parliament following 2008 Elections

Source: "Malaysian general election, 2008" Wikipedia.

The 2008 election failure to maintain a 2/3rds majority in parliament came as a shock to Barisan Nasional who then promised to make reforms and new elections must be held by June 27th at the latest with no date yet in place. Those upcoming elections will be interesting to watch as it presents a real Malay dilemma for all the political parties involved and potentially an opportunity to buy or trade the iShares MSCI Malaysia Index Fund ETF.

To begin with and given the racial make-up of Malaysia, it would be possible for Barisan Nasional to win the upcoming elections without a single Malaysian Chinese or Malaysian Indian vote and that could lead to Barisan Nasional writing off the votes of non-Bumiputera in the future - effectively leaving them locked out of the political system at the Federal level.

And then there is the opposition. There is an old saying that "politics makes strange bedfellows" and there are no stranger bedfellows than Malaysia's loosely-aligned opposition known as Pakatan Rakyat or PR ("People's Pact" or "People's Alliance") which consists of the following political parties:

  • Parti Keadilan Rakyat (PKR). Drawing support from more liberal and educated middle class urban Malays, the PKR (at least officially) wants to see the New Economic Policy replaced by a non-racial economic policy. The PKR is headed by Anwar bin Ibrahim who was Malaysia's Deputy Prime Minister from 1993 to 1998 until he had a falling out with Prime Minister Mahathir bin Mohamad and ended up being jailed in 1999 for corruption and then jailed for sodomy in 2000. Anwar bin Ibrahim was released in 2004 after the sodomy charges were overturned, only to be charged a second time in 2008 on another sodomy allegation. He was then acquitted from those allegations in January 2012.
  • Democratic Action Party (DAP). Drawing most of its support from the Malaysian Chinese community along with Malaysian Indians and even some Malays, the obvious priority of DAP supporters would be to get rid of the New Economic Policy and Bumiputera affirmative action programs. DAP's Secretary General is Lim Guan Eng who is also the Chief Minister of the State of Penang (the only Malaysian state where the Chinese still make up close to a majority of the population) and he is the son of another long-time opposition figure who some Malays have accused of being a "racial provocateur."
  • Pan-Malaysian Islamic Party (PAS). An Islamic party, PAS has support from the northern rural and conservative states. In the past, PAS supporters have called for an Islamic state in Malaysia, but the party has since moderated its position in order to attract non-Muslim support. However, PAS still appears to support increasing sharia laws for Muslim Malaysians.

A wild card in the upcoming elections are the 5.77 million people in East Malaysia who are increasingly unhappy about natural resources flowing out of their territory (which enjoys some autonomy from peninsula Malaysia) and illegal migrants flowing in (who some claim are being granted citizenship in order to shore up government support). Likewise, young Malaysians or rather Malaysian Chinese who have been forced to return to Malaysia after studying or working abroad due to stricter immigration policies in the West along with younger Malaysians voting for the first time could also be unknown factors in some elections for seats where the vote is very close.

Most outside observers believe that after more than 54 years in power, Barisan Nasional is not going to lose the coming elections. However and should they somehow fail to win at least a majority to form a government, then the Malay dilemma will fall squarely on the laps of the opposition.

To begin with, there is little doubt that the first order of business would be to look for and open any Pandora's boxes to find whatever skeletons that Barisan Nasional has left lying around after 54+ years in power as that's what politicians everywhere do when they gain or regain power after a long hiatus. But after any dirty laundry is aired and the skeletons are revealed, then what? The Chinese supporters of DAP will demand a quick end to the hated Bumiputera affirmative action programs (so they can keep their money and go on to make even more of it) while PAS will want more sharia type laws applied to Malaysia's Muslims - something that more liberal PKR supporters probably aren't going to like.

And realistically, it's hard to see many Bumiputera supporting the elimination or even the easing of the affirmative action programs that directly benefit them. After all, look at our own political debates in the USA about preferences or collective bargaining and ask yourself how many votes from state employees Governor Scott Walker probably got after making a few token reforms in Wisconsin or how many votes Republicans are getting from Federal workers who haven't gotten a pay raise in a few years because of roadblocks put up by Congress.

So perhaps one scenario for Malaysia if the opposition were to gain power (that would depend upon who gets how many seats) might be for the Chinese dominated DAP and any East Malaysian parties to try and do some sort of "let us keep our money/natural resources and let the Malays eat more sharia law" type of deal with PAS - something that won't go over too well with Malay PKR leaders or their moderate supporters.

In other words and in the event that Anwar bin Ibrahim does become prime minister, he may have his hands full trying to hold the opposition together while dealing with a government bureaucracy that's filled with entrenched UMNO supporters and a Malay dilemma that will only get bigger. And if the opposition loses this time around, it would likely be Anwar bin Ibrahim's last election bid (he is 65 years old) - leaving some uncertainty as to who would head the opposition in future elections.

The Long-term Case for Investing in Malaysia and the iShares MSCI Malaysia Index Fund ETF

In spite of the Malay dilemma and the uncertainty about upcoming elections aside, there are a number of compelling reasons why Malaysia and the iShares MSCI Malaysia Index Fund ETF would be (in theory...) good long-term emerging market bets for investors. Just consider the following:

  • Location, Location, Location. Located in the heart of Southeast Asia, Malaysia is also part of an industrial corridor stretching into Indonesia. So while low end manufacturing or assembly work gets done on Indonesia's Batam or Bintan Islands and high-end knowledge or headquarters work is done in Singapore, Malaysia gets the work somewhere in the middle.New construction near the Kuala Lumpur Convention Center
  • Not on the Ring of Fire but Rich in Natural Resources. Unlike Indonesia, the Philippines, Taiwan and Japan, Malaysia is safely away from the ring of fire - although the 2004 tsunami did cause some minor damage. However and like neighboring Indonesia, Malaysia has rich deposits of both natural and renewable resources like oil, palm oil, rare earth minerals, rubber and tin.
  • Cheaper To Invest or Live in Than Singapore. Kuala Lumpur is well served by regional airlines and it can potentially be cheaper for expats and professionals to live or base themselves and their businesses in than Singapore. That has encouraged some foreign companies to have their regional headquarters there. However and as a Muslim country, many expats would still choose Bangkok or Singapore for a regional headquarters over Kuala Lumpur.
  • Respectable Economic Growth. For 2012, Malaysia likely had around 5% or so economic growth and will likely have around 5% or so economic growth again this year, but that figure could rise if things start to improve both in China (the country's largest trading partner) and in the United States - unless there is a big hangover when the pre-election spending stops.

. Source: Trading Economics)Malaysia GDP Growth Rate

  • A Sort of Hot Stock Market. Malaysia's stock market gave a sub-par performance of around 10% growth for 2012 versus 20% to 40% growth for some other emerging market stock markets. However, Malaysia was a global hotspot for IPOs last year in part due to strong local demand plus the participation of government pension and asset management firms in buying IPO shares or tranches.
  • The Middle East Connection. Since Malaysia is a more liberal Muslim country, Kuala Lumpur is filled with tourists and students from the Middle East - helping to fuel the real estate market. In addition, Malaysia is also trying to position itself as an Islamic banking and finance hub.
  • Penang is a Major Electronics Manufacturing Hub. The island of Penang has long been an electronics manufacturing hub with a who's who of tech names like Agilent Technologies, Altera, AMD, Bose Corp, Hitachi, Intel, Motorola, Plexus and Seagate having manufacturing operations there. However and with China becoming more expensive along with the 2011 earthquake/nuclear meltdown in Japan and floods in Thailand, disaster free Penang is on the radar map for further technology investments plus Chief Minister Lim Guan Eng is making it easy for foreign investors to set up and expand their operations there.
  • Shared Services Centers or Outsourcing Operations Are Setting Up. Thanks to a large English and Chinese speaking professional class, Malaysia can make more sense than the Philippines for shared service centers (e.g. corporate IT, accounting or finance functions) that must handle work for China or for the whole region or even globally.A future Kuala Lumpur Subway Station
  • The Kuala Lumpur Subway. Anyone who has recently visited Kuala Lumpur may have noticed infrastructure construction everywhere as a Singapore style subway is being built to reduce traffic congestion. Construction of the subway will also trigger a mini-real estate boom as property near future subway stations will increase in value and be further developed in the coming years.
  • Stable Currency. Malaysia allows the ringgit to operate in a managed float against several major currencies, meaning it's more stable than free floating emerging market currencies that can suddenly appreciate or depreciate and hurt exports.
  • Stable Monarchy with No Coups or Insurgencies. Unlike Thailand which could experience a crisis after the current king dies, Malaysia's largely ceremonial monarch is elected every five years by the country's nine sultans. Moreover and unlike Thailand and the Philippines which have had repeated coups or coup attempts, there have been no coups or coup attempts in Malaysia and there are no ongoing insurgencies.

Finally, it's worth saying that Barisan Nasional and former Prime Minister Mahathir bin Mohamad do deserve some of the credit for the success Malaysia has had since independence or at least for not completely screwing things up (like what Marcos did in the Philippines) nor have there been serious race riots since 1969 (as what has repeatedly happened in Indonesia against the Chinese there - and often with government collusion). In part, the latter is due to the media (which is not free from government influence) and reporters who will go to great lengths to discover the occupation of those involved in a crime or incident to avoid printing their name (which tells you their race) or race.

Likewise and unlike the Americans who could not wait to get out of the Philippines (leaving behind a mess) or the Dutch who were quickly booted out of Indonesia (also leaving behind somewhat of a mess) or the French who tried to desperately clink onto Indochina long after their time had passed (and ultimately leaving behind a mess that Americans made an even bigger mess of), the British left their former Malay Federation colonies in an orderly fashion after largely dealing with the Malayan Emergency. In other words, history has dealt Malaysia a good hand to play.

Analyzing the iShares MSCI Malaysia Index Fund ETF

With all of the above in mind, let's take a closer look at the iShares MSCI Malaysia Index Fund ETF which attempts to track the MSCI Malaysia Index. At the end of last year, the iShares MSCI Malaysia Index Fund ETF had an expense ratio of 0.51% and a 12 month yield of 1.58% while as of mid-January, it had a net asset value of around $970 million. A quick look at the iShares MSCI Malaysia Index Fund ETF's top holding reveals the following Malaysian large cap or mid cap stock names:

The iShares MSCI Malaysia Index Fund ETF Holdings (January 16, 2013)

Holdings Sector %
Malayan Banking Bhd (OTCPK:MLYBY) Financials 9.06%
CIMB Group Holdings (OTCPK:CIMDF) Financials 8.97%
Sime Darby Bhd (OTCPK:SMEBF) Industrials 6.28%
Genting Bhd (OTCPK:GMALF) Consumer Discretionary 4.79%
Tenaga Nasional Bhd (OTCPK:TNABY) Utilities 4.63%
Petronas Chemicals Group (PCHEM) Materials 4.29%
Public Bank Bhd (OTC:PUBNF) Financials 4.16%
Axiata Group (AXIATA) Telecom Services 4.12%
Digi.Com Bhd (OTC:DIGBF) Telecom Services 3.9%
IOI Corporation (OTC:IOIOF) Consumer Staples 3.9%
Maxis Bhd (OTC:MAXSF) Telecom Services 3.58%
Petronas Gas Bhd (OTC:PNADF) Utilities 2.74%
AMMB Holdings (AMM) Financials 2.67%
Kuala Lumpur Kepong (OTC:KLKBF) Consumer Staples 2.55%
Genting Malaysia Bhd (OTC:GMALY) Consumer Discretionary 2.54%

One of the above components of the iShares MSCI Malaysia Index Fund ETF that might be familiar to western investors would be Petronas (as in the Petronas Towers), the national oil and gas company which is owned by the government of Malaysia and is also attempting to acquire Canada's Progress Energy Resources.

Another potentially familiar name is the Genting Group, a big Malaysian conglomerate that owns a huge casino resort and theme park in Malaysia's Genting Highlands and recently spent $1 million to gear up for a petition campaign to try and put a casino amendment on the 2014 Florida ballot in order to build a (controversial) Las Vegas style casino resort in Miami (apparently they have abandoned those plans - for now). The Genting Group also owns Star Cruises, the third largest cruise liner company in the world and the largest cruise liner in Asia, and it used to be the sole owner of Norwegian Cruise Line Holdings (NASDAQ:NCLH), but now it has around a 44% stake in the company after its recent IPO.

All told, the iShares MSCI Malaysia Index Fund ETF has around 30.70% of its holdings in financial stocks, 13.15% in industrial stocks, 13.07% in telecom stocks, 11.32% in consumer staple stocks, 10.37% in consumer discretionary stocks, 10.31% in utility stocks and the rest are in other sectors.

And what about the iShares MSCI Malaysia Index Fund ETF's performance? Last year, the iShares MSCI Malaysia Index Fund ETF gave investors a respectable 13.61% return:

And as of the end of last year, the iShares MSCI Malaysia Index Fund ETF also had a 15.48% three-year return, a 6.45% five-year return, a 14.68% ten-year return and a 3.49% return since inception. That may or may not be better than other emerging market ETFs, but at least the iShares MSCI Malaysia Index Fund ETF has steadily risen since the Asian financial crisis - except for a dip during the 2008-2009 global stock market crash and more tellingly, right after the 2008 elections when the Malaysian stock market took a 10% one-day plunge:

Chart foriShares MSCI Malaysia Index (<a href=

However, western investors should remember that Malaysian stocks or IPOs listed on the Bursa Malaysia would be required to have a minimum Bumiputera equity ownership requirement and some of the rules or requirements have changed as recently as November 2012. To get an understanding of what those rules are, check out the Securities Commission Malaysia's webpage: "Bumiputera Equity Requirements For Public Listed Companies."

The iShares MSCI Malaysia Index Fund ETF and the Elections

Traders could find themselves winners if they were to trade the iShares MSCI Malaysia Index Fund ETF both before and after the coming elections depending upon what happens, but such bets could prove to be very risky.

Two possible scenarios that come to mind would be decisive wins either for the Barisan Nasional coalition or the Pakatan Rakyat (PR) opposition coalition (the latter scenario seems much less likely) that would probably lead to the iShares MSCI Malaysia Index Fund ETF (and especially any government linked or owned component of the ETF) making an equally decisive move. However and if the status quo is maintained or Pakatan Rakyat (PR) were to pick up seats, things could get interesting and much more uncertain both for Malaysia and for the iShares MSCI Malaysia Index Fund ETF.

Under a parliamentary system of government, the group that fails to win enough seats in an election could still attempt to form a government through backroom deals with smaller parties or individually elected politicians from other parties while the other group that "wins" tries to hold together a governing coalition through backroom deals with smaller parties or individually elected politicians from other parties. In other words, it could be unclear after all the votes are counted as to who will ultimately be a "winner" and form a new Malaysia government - which could mean volatility for the iShares MSCI Malaysia Index Fund ETF that savvy traders might be able to take advantage of.

What's Next For Asia's Overlooked Emerging Market?

For investors with a long-term time horizon, it's worth noting that up until the Asia financial crisis, Malaysia had China sized emerging market economic growth rates. But due to the slow drip of Malaysian Chinese professionals leaving the country along with the inefficiencies created by the New Economic Policy and "Ali Baba" system, Malaysia is unlikely to see those kind of growth rates in the immediate future. With that said, it's increasingly difficult for China to have China-sized growth rates as well while most Western countries will be stuck at zero or below unless they keep printing, borrowing and spending money that is simply no longer being created by their economies.

It should also be remembered that regardless of what happens in the upcoming elections, there will be an economic hangover afterward. That's because whenever a democracy has elections where politicians are trying to stay in power or get themselves into power, lots of money gets thrown around with all that spending usually coming to a halt after the votes are counted (or recounted).

Nevertheless and in spite of the Malay dilemma and other issues mentioned above, Malaysia and the iShares MSCI Malaysia Index Fund ETF could still give long-term investors a decent and safe (but unspectacular) return (after the elections are done) verses other emerging markets while short-term investors and traders with a big stomach for risk may be able to make additional profits during the upcoming elections.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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