Quick Take: Amid the gloom shrouding global markets, the Far East has provided some solace for weary investors. Led by the burgeoning economy of South Korea, markets in the Pacific Rim have held up nicely this year. One portfolio that invests in this region, the Investec Asia Focus Fund (IASMX), has gained 8.1% year-to-date through July 31, while the average regional emerging markets portfolio has declined 5.2%. Based in Hong Kong, portfolio managers Robert Conlon and Agnes Chow seek out undervalued stocks throughout the Asia-Pacific region, excluding Japan.
The fund is the surviving entity of a merger between two other Investec portfolios — Investec Asia New Economy Fund and the Investec Asia Small-Cap Fund — which occurred in January 2002. Conlon and Chow managed both funds prior to the merger. With assets of only about $4 million, the New Economy Fund was not deemed a viable investment vehicle, so it was folded into the Asia Small-Cap Fund, which then changed its name to Asia Focus Fund.
The Full Interview:
S&P: What are your buy criteria and what kinds of stocks do you look for?
CONLON: We use a strictly bottom-up approach to find undervalued stocks in Asia, excluding Japan, in which the underlying business is earning excess returns on invested capital. We also look for companies with positive earnings revisions. We use a proprietary screening methodology to score every stock in our universe. We then focus our research efforts on selecting from among the higher-scoring stocks.
To illustrate how undervalued Asian stocks currently are, the weighted average P/E for this portfolio is about 9.9 relative to this year’s projected earnings.
S&P: How concentrated is the fund and how large?
CONLON: We currently have about $22 million in net assets and 38 holdings. We typically hold between 35 and 40 stocks.
S&P: Why do you keep the fund so concentrated?
CONLON: We believe in a systematic approach to investment management. We are looking for exceptional stocks that we believe are being mispriced by the market. When we find these companies, we want them to contribute materially to the portfolio’s performance. We don’t want to dilute potentially high returns by owning too many stocks.
S&P: When you merged the New Economy Fund into the Asia Small-Cap Fund, did you change your investment styles in any way?
CONLON: Our investment process did not change, but the investment objective of the surviving fund was widened to include large-cap companies.
S&P: How has the fund performed this year relative to its benchmark?
CONLON: Through the end of July, the fund was up 8.1%, while the index, the MSCI AC Far East Free (Ex-Japan) Index, rose 0.2%.
S&P: What are your top holdings?
CONLON: As of June 30, the fund’s ten largest holdings are Samsung Electronics (8.9%); Kookmin Bank (5.1%); Taiwan Semiconductor (4.1%); Hong Kong Electric Holdings (3.4%); Hyundai Mobis (3.4%); Shinhan Financial Group Ltd. (3.4%); Texwinca Holdings Ltd (3.3%); Resorts World Berhad (3.2%); ChinaTrust Financial Holding (3.1%); and Posco (3.1%). These ten stocks represent 41% of the fund’s total assets.
S&P: Your largest holding, Samsung Electronics, has performed extraordinarily well this year. Could you discuss this company?
CONLON: Based in Korea, Samsung Electronics is Asia’s largest company. As such, for our fund to post excess returns from Samsung Electronics, we like to keep a relatively large weighting in it. Despite its strong price gains this year, the stock is still only trading at about 7.2 times this year’s consensus earnings and, consequently, we consider it to be quite cheap.
S&P: How does Samsung compare with their global rivals such as Nokia, Micron Technology and Sony?
CONLON: They compete with Nokia in manufacturing mobile handsets. In this regard, Samsung has a higher margin than Nokia and they are gaining market share more quickly. Samsung competes with Micron Technology in the manufacture of dynamic random access memory, or DRAMs, a type of memory used in most personal computers. Samsung keeps its costs lower and is the more profitable producer, while Micron is incurring losses. Samsung competes with Sony in the consumer electronics arena. Samsung is more profitable and is the leader in new technologies such as flat-screen display panels.
S&P: A few weeks ago Taiwan Semiconductor gave a somewhat gloomy outlook for the second half of this year.
CONLON: Taiwan Semiconductor announced a lower-than-expected forecast for its third quarter 2002 results, which sent the entire semiconductor sector into a tailspin. Fortunately, we had already reduced our exposure to the company about two weeks before that announcement. Moreover, in the same week, we eliminated entirely our position in United Microelectronics (UMC), another Taiwan company that directly competes with Taiwan Semiconductor. In both cases, we sold or reduced our positions because the earnings revisions had turned negative.
S&P: On the whole, how is the Asian semiconductor industry faring this year? What is your outlook for the sector?
CONLON: The industry, as a whole, provided positive surprises during the first quarter of 2002, performed in-line with expectations in the second quarter, and has disappointed analysts with its outlook for the third quarter. We don’t really have an outlook for the sector for next year. However, we will look at the change in consensus expectations on a company-specific basis.
S&P: Tell me about Texwinca, the Hong Kong garment maker?
CONLON: Texwinca manufactures clothes in China for a diversified customer list of retailers, which sell their wares globally. The stock is currently trading at a P/E of about 10, and has averaged an annual return on equity of 25.9% for the last five years, while sales growth has averaged 23% per annum.
S&P: Can you discuss any recent additions to your portfolio?
CONLON: Recently we added to our position in Resorts World Berhad, a Malaysia-based casino operator which is earning high returns on investment. They have recently been surprising on the upside, having increased the number of hotel rooms at their site.
S&P: What are your top industry allocations?
CONLON: As of June 30, the fund’s top industry allocations included electronics (14.6%); commercial banks (10.3%); retail (9.6%); airlines (4.6%); finance (4.4%); semiconductor components (4.1%); and computer equipment (3.6%).
S&P: What are your top country allocations?
CONLON: As of June 30, the fund’s top country allocations were South Korea (32.1%); Hong Kong (23.4%); Taiwan (15.8%); Malaysia (11.0%); Singapore (4.7%); and Thailand (3.1%).
These allocation are purely the result of our bottom-up investment style. We don’t seek to match or outweigh the benchmark’s allocations. However, relative to the benchmark, I can say that we are presently overweight in Korea and Malaysia, and underweight in Hong Kong and Taiwan.
S&P: Has your exposure to South Korea been steadily increasing this year?
CONLON: Yes, it has been, although just recently we have marginally reduced it.
S&P: Where have you been cutting back?
CONLON: Initially in Hong Kong, and more recently in Taiwan. The electronics sector in Taiwan generally has had negative earnings revisions, and this represents the largest component of the Taiwan stock market.
S&P: Why do you have no exposure in the Indian subcontinent or Australia-New Zealand?
CONLON: They are not in the benchmark index. However, we would invest in India if we thought the circumstances for that country we exceptionally good. We currently do not think they are. We would invest in Australia if we thought the circumstances for Asia were exceptionally bad — a repeat of the Asian financial crisis, for example, from a few years ago. But we currently like the fundamentals and outlook for Asia.
S&P: Although you select stocks on a bottom-up basis, are there any overall ‘themes’ in Asia that you’re playing now?
CONLON: On a sectoral basis, we are overweight in service industries. This rather broad category includes retailers, utilities, and transportation. We also like the domestic economies in Korea and Malaysia, particularly banking, the oil and gas sector in China, the mid-sized industrial sector in Hong Kong that is operating out of China, and the industrial sector in Korea, primarily steel and automotive.
S&P: When do you sell?
CONLON: When a stock’s score drops, we will review it. That is based on our internal screening process. We keep no stocks in the fund that have a below-average score based on our investment methodology. If the earnings revisions for a company turn down, or if the shares become too expensive on a cash-flow return on investment basis, then we will sell.
S&P: Why have we been seeing decent earnings growth in Asia, outside of Japan?
CONLON: Because economic growth in Asia has been strong and the companies there have improved their profitability.
S&P: U.S. investors pulled out of Asian stocks back in 1997-98, when those markets collapsed. Have those investors been coming back?
CONLON: From evidence I have seen, I don’t think they have generally come back yet.
S&P: Do you visit with company managements? If so, are they very forthcoming with information?
CONLON: Yes we visit our companies, and corporate governance has improved, leading directly to improved returns for shareholders.
S&P: Has the weakening U.S. dollar hurt or helped the performance of Asian markets this year?
CONLON: It has helped returns as local stock market prices have been translated back into higher U.S. dollars.
S&P: Doesn’t a weakening U.S. dollar mean that Asian countries will be able to export less product to the U.S.?
CONLON: If the weakening dollar is a sign that the U.S. economy is doing very badly, then the answer is yes. However, I don’t think the higher Asian currencies will impact competitiveness as Asia remains very competitive. Profits from the U.S. will be reduced when translated back into local currencies.
S&P: Why have the Korean markets been so strong?
CONLON: All segments of Korea have done well, but the domestic economy is particularly strong.
S&P: The South Korean currency has been very strong. Is this hurting their exports to the U.S.?
CONLON: Not yet. Exports are priced in U.S. dollars and therefore costs, those in the local Won currency, may increase in U.S. dollar terms, but Korean businesses should remain very competitive.
S&P: Mainland China has linked its currency to the U.S. dollar. Does this help or hurt them as the dollar weakens?
CONLON: It makes them marginally more competitive.
S&P: Are countries like Korea and Hong Kong anxiously waiting for the U.S. economy to rebound?
CONLON: Korea is expected to have GDP growth of about 6% this year, so I don’t think they’re waiting for a U.S. economic rebound! Hong Kong still has problems with the residential property price bubble of 1996 and 1997 as many potential consumers have negative equity in the properties.
S&P: What is your outlook for Asia, excluding Japan), for the remainder of the year?
CONLON: I think they’ll outperform the U.S. market. Asia’s P/E level is back to where it was in early 1993 or late 1998. In 1993 and 1999, the stock markets in Asia were very strong, up well over 50% in both cases. A bear market in the U.S. may prevent these kind of gains this time, but I still think they’ll do well.