Investment report: The Asian answer

There is more to investing in emerging markets than the Brics, says Norman Villamin. Look to the “Next 11”
January 25, 2012

For many in the investment community, emerging markets will remain in the limelight for the foreseeable future, particularly the Bric economies of Brazil, Russia, India and China. Indeed, we will almost certainly have to look to these large, fast-growing nations to take up the slack in global growth created by the slowdown in the west. Other large markets, such as Indonesia, may also contribute, but the onus will fall upon the Brics.

Recently we have seen growing interest in a group of smaller emerging markets, sometimes dubbed the Next 11. These countries (Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, South Korea, Turkey and Vietnam) offer an interesting theme, but many of these markets are relatively illiquid, which presents problems for international investors. Others, like Mexico and South Korea, rely on global trade, which exposes investors to many of the same concerns facing western economies.

As a group, the Next 11 offer an interesting long-term opportunity, but some, such as Indonesia and the Philippines are particularly attractive. Indeed, they and others that make up the Association of Southeast Asian Nations (Asean) have weathered the recent economic storm well.

Countries such as Indonesia, Malaysia, Thailand and the Philippines have largely avoided many of the growth downgrades that their peers experienced in 2011. Equally important, while broader emerging market equities were weak in 2011, these key markets showed modest gains. Much of this was due to the nature of their respective economies as well as their policy responses in 2011.

By using currency policy effectively in early 2011, these large nations contained inflationary pressures as global food and energy prices surged. Similarly, later in the year as US growth concerns and the European debt crisis weighed on the global economy, these countries demonstrated the benefits of their large domestic economies and relatively small reliance on trade as buffers against the impact of global slowing.

In the longer-term, recent under-investment in infrastructure presents an opportunity. The 1997-98 Asian crisis left many of these nations hesitant to replicate the overbuilding seen in the early 1990s, and infrastructure development has failed to keep up with the robust growth of the past decade. So a pick-up in overall investment as infrastructure catches up with the needs of their growing middle classes could boost economic growth.

Though not as large as the Bric economies, many of Asean’s largest members (Indonesia, Thailand, the Philippines, and Malaysia) present an interesting balance of large, stable domestic economies, rising infrastructure investment and steady trade balances, capable of generating high and relatively consistent growth. These characteristics provide some defence against global concerns that may weigh on some of the more trade-oriented emerging economies.

While opportunities exist within these countries, currency volatility remains a key risk, especially if the situation in Europe continues to deteriorate. Should the European crisis stabilise, Asean currencies should broadly track the dollar, which is likely to be among the strongest of the major currencies.

Looking to 2012, growth across the south east Asian economies will be stable at around 5.5 per cent. Inflation should moderate this year, although government policy action in the latter part of 2011 suggests inflationary risk remains, particularly in Indonesia.

The region’s largest equity markets fared well in 2011. They outperformed others in the region in the first half of the year thanks to domestic policies to combat high global oil prices. In addition, the sizeable domestic economies of Indonesia and the Philippines supported corporate earnings as global growth expectations declined.

Following last year’s floods, equity valuations in Thailand are historically cheap, although earnings forecasts may be revised downards early this year. Flood recovery efforts are expected to mitigate risk and drive household and infrastructure spending, which will benefit sectors including banks, power utilities, energy, building materials and food. Indonesian valuations remain high; even allowing for the premium returns Indonesian companies have earned since 2002. This is likely to limit scope for further appreciation in spite of an otherwise attractive outlook for its economy.

Malaysian equities, which have above-average dividend yields, provide a potential sanctuary for investors against regional and global volatility. Valuations are around their historical average and Malaysia’s Economic Transformation Plan and possible elections in 2012 will both help to stimulate growth.

Emerging markets are likely to supplant the west as the generator of global growth in the coming years, but investors should not rely only on the Bric countries for returns.