Not so Inscrutable

Asia funds have not fared well in years. How do you make the argument that it’s a good idea to invest in such funds? Are the Pacific Tigers–Hong Kong, Singapore, Taiwan, Thailand, Indonesia, South Korea–reverting to their growth days of the early 1990s? These countries are all in relatively different [growth] stages and I compare one country to another by basic statistics, such as per capita GNP. If you look around the region, Hong Kong and Singapore are the only two countries outside of Japan that have per capita GDPs comparable to most of Western Europe and the United States. What makes the region so exciting to me is that although some of the smaller countries have achieved relative wealth, the vast majority of people living in Asia still have a long way to go to catch up with even some of the poorer European countries. And everything I see happening in China now reminds me of the changes that were occurring in Korea and Taiwan and Hong Kong and Singapore back in the late ’70s and early ’80s. I have a high degree of conviction that in 20 years’ time China will have achieved comparable success in its financial systems.

Over the past five years MACSX has consistently beaten the MSCI EAFE index. How has it done this, particularly once the bear market started in March 2000? I think the focus on securities that produce both current income and long-term capital growth has been a particularly positive. Declining interest rates across the region have [also] been positive for high-yielding stocks. Investors have learned to rely more heavily on absolute indications of financial health, the most obvious of which is the payment of the most current dividend. The natures of the companies that have historically paid dividends make them somewhat immune from the more dramatic impact of global trends.

You list several advantages to convertibles, including limited foreign exchange risk. What are some other advantages the average investor might not pick up on? Historically in these types of markets there has been arbitrage activity. In the late 1980s and early 1990s, it was difficult for investors to borrow stock and short individual investments in these markets. The arbitrageurs did not take out the inefficiencies between, for example, convertibles and ordinaries. And therefore it was possible to find underpriced convertible bonds. As these markets have opened up and become more sophisticated, there is less inefficiency. It is much clearer to me that the arbitrage community plays a much greater role in the pricing of convertibles than do long-only buyers of convertibles. And since many of those players were not able to participate in the Asian universe until relatively recently, both markets were left inherently inefficient.

By being diversified across all industries and sectors, and investing in companies of all sizes, how do you narrow your investment choices? We focus on three particular sectors, with the first being the consumer. One thing we can be relatively certain of is that over the next five, 10, and 15 years, average per capita incomes will rise faster in Asia than they will in other countries. If you can find a business that is exposed to rising living standards in Asia, you have at least one thing working for you. The second focus is the financial sector. None of these long-term trends we believe in could occur without continued restructuring in the financial sector, and we are very encouraged by what we have seen over the last three or four years in Korea. We are also very encouraged by restructuring in Hong Kong and Singapore, and by the long-term trends in restructuring the Chinese banks. The third focus is technology. Technology will play a vital role in long-term growth, but there are not that many technology-related businesses that have issued convertible bonds or that pay high equity dividends. The exception is the telecom sector, where there are a number of countries that have issued either straight or convertible bonds; two examples would be Korea Telecom and China Mobile.

Many American companies have been “challenged” to provide accurate financial data to investors. Is disclosure better or worse in Asia? There is no doubt that the highest standards of disclosure, transparency, and governance are in countries like the United States and developed countries in Europe. But the rate of improvement in Asia is probably significantly higher in that they are starting from a lower base. The pre-1998 disclosure practices in many Asian countries were very poor. The dependence on bank debt supported by government programs in the pre-1997 environment led to overleveraged balance sheets. The regulatory environment was very weak. But all of those things have improved dramatically in the post-crisis environment.

Why did you choose to follow a bottom-up approach to investing? Previously I worked for a large organization with multiple offices, with people based all over the world; all of our portfolio decisions were made on a matrix basis so we would start from the top down and an economist would determine how much to be put in a particular country. Once that decision was made, a local stock analyst would decide which stocks to pick. My observation over the years was that the performance that model produced wasn’t very good, and part of that was because there wasn’t a cohesive approach to the portfolio. Over the years we have come to the view that the best approach is to find the best companies in the countries in which we are investing and hold onto them for the long term.

Do you maintain the same number of stocks every year? It’s not a hard and fast rule. One of the philosophies that we have is to stay fully invested. We don’t believe we can particularly time when we should be in cash or not, and the best service we can do for our investors is to remain as close to fully invested as we can. We maintain about 45 positions in the portfolio and a new position must replace an existing position. So we are constantly working to upgrade the portfolio. We like to be diversified by country as well.

You mentioned new holdings must replace old ones, so what is your exit strategy? If there is a significant risk to the future stream of income and we think the dividends are going to be eliminated or cut, we would exit the position. If through price appreciation the yield has fallen below the average of the local index, that alone might cause us to sell, particularly if we find a replacement that is offering a higher current yield. Really, it is about sustainability of income.

Staff Editor Megan L. Fowler can be reached at [email protected].