18/02/2011 (Incisive Media Investments) - Maria Merricks examines the concerns surrounding China and India and looks at prospects for some of their emerging neighbours.

China and India have long been the darlings of the Asian emerging markets story. However, lately negative headlines have surrounded these economies. Inflationary pressures are causing concern, and fears of a Chinese property bubble are adding to the noise.

Considering the compelling Asian growth story, is it time for investors to look for opportunities elsewhere in the region? While managers say yes, they also agree China, in particular, should not be overlooked.

Ewan Thompson, manager of Neptune’s Asia Pacific Opportunities fund, says the aggressive measures the government and central bank are taking to stop bubbles emerging is positive for the medium-term health of the Chinese economy.

While food price inflation remains a concern, Thompson is confident a slow and steady structural increase in core inflation should not be viewed negatively. Core inflation will mean an increase in wages and consumer power, a key story for China in the next 10 years, he says.

Andrew Beal, manager of the Henderson TR Pacific Investment Trust, is also optimistic. He forecasts inflation at 4%-6% this year – a shade higher than the Chinese are comfortable with, but nothing to panic about.

For Beal, the country still offers plenty of opportunities. The fund has a large exposure to the travel and leisure sectors, which he is confident offer excellent long-term growth.

However, while China continues to provide compelling opportunities, it sits in the middle of “the enormous powerhouse” that is Asia, Thompson says.

“What you have surrounding it is a number of economies with similar, if
slightly smaller, opportunities in terms of themes such as demographics and capital income growth. Some of these economies are pretty significant.”

Indonesia
The Neptune and Henderson managers agree, for example, with the long-term investment case for Indonesia: their funds have 8.5% and 4.8% exposure respectively. Its combination of positive demographics, geographical location and the right commodities makes it interesting.

At 245 million, Indonesia’s population is the fourth largest in the world. And approximately half of the inhabitants are under 30, meaning a large number of people are well positioned to come into the consumption phase, says Thompson.
“The capital income of the country is the second fastest growing in the world after China. Combined with the demographics, this makes for a very powerful mix.”

A key dynamic in the Asia Pacific region is which side of the commodity price trade a given country is on. India, for example, imports 70% of its crude oil requirements – a key problem for the economy, certainly as inflation rises.

Commodity exporters in the region, such as Indonesia, are the beneficiaries. The country’s geographical location makes it a major exporter of palm oil and thermal coal, to the huge markets of China and India.

Adaro Energy is a stock example to play this theme, says Thompson. The company is a major coal exporter in the region, but also benefits from domestic demand as Indonesia’s economy grows.

“Although the country ultimately benefits from commodity exports, it is not just a pure commodity play. The trickle-down effect is also exciting.”

Vietnam
Another country creating ripples is Vietnam. Jason Pidcock and Zoe Kan of the Newton Asia Pacific Equities team say the economy is in its nascent stages of growth thanks to restructuring, market reform and demographic factors.

“With a low market cap to GDP ratio, investors have begun looking to this market. There is significant potential for further reform to take place and its pool of cheap labour provides scope for industry development outside of its primarily agricultural-based economy,” they say.

Despite this, the pair have no exposure to Vietnam because they do not believe it currently presents an attractive investment opportunity relative to other developing Asian economies. They see more sustainable growth coming from Thailand and Indonesia, “where valuations are attractive and a more sustainable political system is in place”. The fund has a 3.2% and 2.1% weighting to these countries respectively.

“Vietnam’s economy is volatile owing to an unstable currency and the lack of a macroeconomic framework,” say Pidcock and Kan. Indeed, currency concerns were reaffirmed earlier this month when the dong was devalued by 7.2%.

Vietnam pure play fund house, Dragon Capital, says the devaluation shows the government is serious about restoring confidence, although it admits everything depends on policy follow-up. The group’s CEO, Dominic Scriven, says the 7.2% hit may seem large but there is a twist.

“The new rate has actually prevailed in business transactions for the past few months, so we believe the de-val will not have a drastic impact on macro outcomes. Tellingly, there was little reaction from the stock market,” he says.

Scriven is insistent Vietnam’s growth story is too good to ignore. It is a frontier country with literacy, work ethics and underlying entrepreneurial dynamism, reinforced by perfect demographics and reignited by market reforms.

“It is moving from pure agrarianism into low-end export manufacturing, with cheap skilled labour as the competitive advantage, and urbanisation and the consumer economy following in train – a lot like Thailand in the 1990s.”

With inflationary pressures surrounding China and India, investors may look to some of Asia’s frontier markets. Maria Merricks asks Dominic Scriven, CEO of Dragon Capital, what Vietnam has to offer
How has the devaluation of the dong affected the macroeconomic outlook for Vietnam?
It came as no surprise that the State Bank of Vietnam devalued the dong earlier this month. The 7.2% hit might seem huge but the new rate has prevailed in business transactions for the past four months (and was moving up before that too) so we believe it will not have a drastic effect on macro outcomes.

The effect will mostly be confined to the state-owned enterprises (SOEs), which will see their privileges eroded.

What role does the country play in the Asian growth story?
Vietnam remains one of the most dynamic growth stories in the region, with GDP cruising at 6.5%-7% a year into the foreseeable future.

Meanwhile, the country benefits from baby boom demographics, creating a population of 90 million, half of which are under 25. High levels of literacy and basic education has provided a labour force that is not only huge and skilled, but also cheap: there are 1.5 million new entrants to the workforce each year, keeping wages low.

A large domestic economy, backed by irrepressible consumer spending and rapid urbanisation, is a further powerful driver.

Which sectors offer the best opportunities?
We look for companies in sectors we think will benefit from the main themes in the country. The themes we see are: income growth and development of a middle class; demographics and urbanisation; financial development and modernisation; and export infrastructure build-up.

We like food and beverage stocks in the consumer sector and banks and insurance in financials. Our top holdings include leading dairy products manufacturer Vinamilk, and Vietnam’s number one private commercial bank, Asia Commercial Bank.

What are the risks and challenges involved with investing in Vietnam?
Risks and challenges consist largely of the government failing to institute much-needed improvements in macro policy. This would mean the economy and stock market would continue to be whipsawed by an ongoing vicious cycle of SOE over-expansion, double-digit inflation, high trade deficits and chronic currency weakness.

We are confident the government has recognised it must institute reforms after recent discussions at the Party Congress, and dissent from the National Assembly.

Is investing in a pure-play Vietnam fund favourable over a general Asia Pacific fund?
We do not claim it is – or is not. We offer our funds for generic exposure to Vietnamese-listed equities, ideally with outperformance on top. It is up to the investors to decide how they want to integrate that into their own regional strategies.