As The West Slips, Asia's Outlook Is Bright

As our longer term investors should know by now, there are two things we believe are inevitable, not as surely as the sun will rise, but close enough.

These are: a longer term trend for the weakening of the US dollar against Asian currencies, and the increased spending power of Asian consumers.

To that end, our fund has been - and will continue to be - positioned to benefit from these two major themes.

Given recent events in the US and continuing uncertainty over outlook for the US economy, the former theme is probably not a major contentious issue.

It has, however, been a little more difficult to pin down the latter theme with more than anecdotal and outdated macro data, until now that is.

Financial services company CLSA recently ran a series of surveys across the region - one of the most comprehensive ever of Asian middle class spending behaviours.

This opened our eyes to some interesting facts and certainly fully supports our view on rising spending power in Asia.

This is what CLSA's Head of Broking, Jonathan Slone says:

"Old measures such as per capita and household income are no longer the best yardsticks to understand economic behaviour.

In many economies, home ownership is high and debt low.

Rising asset prices mean that consumer spending patterns are far in advance of what would be expected simply taking income into account.

"Access to education and advances in communication have propelled the region's populations into a middle-class workforce where national boundaries are less relevant to lifestyle and choice than they have been in the past.

"Middle-class expectations in Cincinnati, Frankfurt, Shanghai or Mumbai are rapidly converging.

It is now comfortably within reach to be able to get hold of the money to buy a home, drive a car, educate the kids, travel abroad and save enough money to retire happily.

"Asians are having fewer kids, have more discretionary income, and are more international in their consumer choices."

Household incomes for Mr & Mrs Asia have risen but vary significantly, depending on where they live.

Real per-capita income has more than doubled in China, and has risen by 55% in India over the past 10 years.

But household income is up barely 10% in Indonesia and Thailand.

The varying macro-economic backdrop affects consumption patterns, with momentum in China and India generally ahead of other countries.

Rising income, and a more modern lifestyle, older marriage age, higher divorce rates and generally lower fertility rates for women means that growth in the size of the labour force is expected to slow dramatically over the next decade.

In general, there is greater optimism about the future.

That is particularly so in India where 63% of respondents expect incomes to rise over the next 12 months (compared with 50% who have seen it go up in the preceding year).

The Philippines, too, is optimistic.

Some 44% of households expect their incomes to rise but only 27% saw it go up in the past year.
63% of households in India expect income to rise in next 12 months
63% of households in India expect income to rise in next 12 months

There is greatest caution however in Taiwan where 29% of the households report an increase in income over the past 12 months, but only 18% believe incomes will go up over the coming year.

Rising income levels, combined with increasing confidence about the future, are likely to propel an increase in spending by households.

The evidence over the past 10 years indicates that consumption growth has been phenomenal in those countries with the highest GDP growth rates that have come from the lower income levels.

To conclude, there is still a lot of room for Asia's consumer to leverage up.

That applies not only from the point of view of mortgages, but also from consumer credit point of view, whether through direct personal loans or through credit card spending.

Rising disposal income inevitably leads to more discerning purchases and that means consumers shifting attention from price to quality.

The low level of share ownership will also provide some structural shift in valuations as more investors become interested in investing in the stock market.

Especially as their total net worth is bolstered by a rise in other asset values.

Asia Fights Back Despite Dollar

Despite big losses and heads rolling at commercial and investment banks, flows into Asian markets continue to remain strong.

The billion dollar (I use billion because a million dollars seems like nothing nowadays) question is whether Asia can decouple in the event we see a significant slowdown in the US economy.

I have been and remain quite bullish over the rising middle class and domestic consumption story in Asia.

It is clear that Asian consumers are seeing increasing discretionary income and are demanding better quality products, lifestyle and more choices.

However, whether this theme/trend is sufficient to offset a worse case scenario of a global slowdown, driven by a more significant than expected slowdown in the US economy is another issue.

Citigroup's Strategist, Markus Rosgen, recently wrote an excellent thought-provoking piece on this specific topic, debunking the fast becoming consensus opinion that Asia can potentially decouple and go on its own steam if other regions, or more specifically, the US starts to slowdown.

Nobody will argue against the fact that Asian domestic consumption is on the rise because Asia has become the manufacturing base for the world.

The key question is whether Asian demand has grown enough to absorb demand from a slowdown in their key customers.

From a top down perspective, it is difficult to see how slower demand from the US will not hit the Asian economies, especially the more export driven countries.

Some economists would like to argue that any slowdown in the US could be offset by strong growth in Europe, and consequently continue to drive export growth in Asia.
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But there is still some correlation between European and US growth rates, albeit the correlation is not as significant compared to US and Asian economies in the past.

However, with globalisation, the correlation between different countries growth has risen not fallen, which makes complete decoupling trickier, if not wishful thinking.

Still, in my opinion, this is a circular argument; globalisation has linked economies more, not less.

A slowdown in a region, especially one the size of the US, is sure to have some impact, the question is how direct an impact, and the quantum of the impact, the answer to which will also vary depending on which country in Asia we're looking at.

From a bottom up perspective, I have definitely been seeing more anecdotal evidence of rising demand from Asia itself.

There's no doubt luxury market sales have been tremendous. China is now one of the top five largest buyers of high end luxury goods in the world.

Insatiable demand from not only China, but Asians in general have been driving luxury watch sales.

Swiss made luxury watch sales are expected to grow by 15-20% per year, up from 8-12% over the past few years.

In my last trip to Hong Kong, I surveyed a few luxury watch retailers to see how their sales were doing. In most of these shops, their Patek Philippe displays were bare.

One sales person noted if they had more Pateks to sell, they would make more money! Apparently mainlanders had been snapping up any stock that were coming in.

Looking a little more down to earth, the textile sector is an interesting one to analyse.

Clothing is the often the top non-necessary expenditure.

The textile sector in China has taken a bit of a beating over the past couple of years because they expanded aggressively pre-quota and consequently have been left with significant overcapacity.

This capacity has been slowly taken up, a lot of it from domestic demand.

I was recently at the Canton fair in Guangzhou, probably one of the world's largest trade fairs.

Interestingly, talking to some of the exhibitors there, they have been seeing a significant increase in not only domestic but also Asian buyers.

Now some of these are because western manufacturers have set up buying offices either in HK or elsewhere in Asia, but some are Asian based demand. In particular, Middle East, Africa and Latin America transactions have been increasing in significance.

In my opinion, Asian economies are inextricably linked to global economies.

I think analysis that shows that Asian economies will completely decouple if we see a global recession is hopeful at best, completely misguided at worse.

On the other hand, Asian domestic consumption as a potential driver of future global growth is not a castle in the sky dream. In my opinion, it is a matter of time.

If you ask me whether it is strong enough to take up the slack for a US slowdown, yes, for a US recession no, and certainly not if we see both US and European slowdown.

On the other hand, I believe the recovery in Asia will be faster, than expected if we do see a slowdown.

Balance sheets (both government and private) are stronger than they have ever been in the past.

And most importantly, the growth potential from domestic consumers will remain as promising now as it will in the next few years, even if growth takes a backseat when some slack occurs in external demand.

Diamond rings in China

Having been investing for more than 15 years, I find that I am still constantly learning on how to invest.

No matter how much you read, you never really learn unless you make a mistake.

It is human nature to learn by making mistakes, which is why you shouldn't really repeat a mistake.

One of my favourite anecdotes on making mistakes is a story about a young executive at a large multinational firm.

His decision had effectively cost the company $50m and he submitted his resignation to take responsibility for his actions.

However, the president of the company refused to accept it. The employee was confused and asked why the company did not want to fire him.

The president replied: "The company has just spent $50m to train you, I don't think we will be letting you go so easily."

:: Last month, I looked at one of Korea's largest casual wear retailers, which also has a fast-growing presence in China.

This is not surprising in a way, given how crazy all things Korean are in the rest of Asia.

Growth prospects in China looked enormous, with the retailer looking to open 150 stores in China from zero two years ago - and with a target for 250 stores within the next two years.

However, having visited a number of casual and fashion wear makers and retailers in Hong Kong, Taiwan and Korea, it was clear that the casual wear business was undergoing some difficulties throughout the region.

Casual wear - defined as clothes that do not really change every season, are affordable, but not fashionable - was fine for consumers five to 10 years ago.

But with rising income, consumers in Asia were now leaning more towards fashionable wear - more expensive, seasonal and trendy - resulting in stale and sometimes negative growth in casual wear business across the region.

Looking through some of the stores in Korea, we wouldn't probably have been amiss standing in a Giordano or a Bossini store.

Having said that, I was seduced by the Chinese growth story, and was prepared to give Korean casual users the benefit of the doubt.

Recent results from the Korean retailer showed I was a little optimistic in assuming that Korean casual buyers would be any different from other casual wear buyers in the region.

The casual wear market is stagnating, and although sales growth had been propelled in Korea by the rapid expansion of hypermarket stores, the spectre of rising inventory risk also came with it.

The company had to make significant provisions and discounts for past season stocks, and sales growth is expected to slow even for some of its newer casual brands.

Although in the longer term the China growth story will probably overshadow current concerns, there are probably going to be some adjustment pains in the short term.

:: I recently visited an alloy manufacturer's factory in Shanghai.

The company has started opening auto service centres in the city and is looking to expand its service centre rapidly.

Most Chinese are only starting to buy their first car and as such are still new to the concept of accessorising their new vehicles.

Alloy wheels are currently considered luxuries which the average Chinese is unlikely to be focusing on at the moment.

But if the trend across Asia holds true, this is going to be big business in China in the coming years.

Alloy outsourcing still remains low and demand for good quality alloy manufacturing capacity remains strong.

With full order books for the next three to four months, this factory is selling as fast as it can produce or increase capacity.

However, if readers think this is not a competitive market, think again. In China, the pricing goes by the kilo! The heavier the more expensive, which somewhat defeats the purpose of actually changing to alloys!

However, quality and brand awareness is starting to seep through as new manufacturing technologies actually reduce the amount of aluminium required per wheel, reducing the weight of the alloy whilst improving the performance.

As Chinese consumer awareness increases, so will sales of branded alloy manufacturers.

:: I recently visited a chain of jewellery stores in Shanghai. The chain currently has around 15 retail outlets in China, with plans to open another 10 or so a year over the next few years.

The shops were well laid out and modern looking, and wouldn't be out of place in other Asian cities.

Their best selling jewellery items are wedding bands, or infinity rings, which make up almost a quarter of their total sales.

The purchase of engagement rings is still relatively rare in China, with fewer than 10% of new couples even purchasing engagement rings.

However De Beers is working hard to educate the Chinese consumer on the importance of buying a diamond ring that costs two months' salary' for their wife-to-be.

In China anything that can be seen to imbue status is all the rage, and diamond jewellery is undoubtedly one of the highest status symbols you can wear.

Taking quick stock, I also noticed that fewer than 30% of women walking on the streets had pierced ears, let alone earrings.

By the way I got some funny looks for staring at women's ears, but hey, it was all in the name of due diligence. I have no doubt that growth in this segment is going to be enormous.

After China: Where's The New Frontier?

After years of hearing people say how much deflation China has exported, I believe they may start singing a different tune soon. The fact is, China was the lowest cost producer of everything.

However, as I noted in one of my past memoirs, that is no longer the case as countries like Vietnam, Laos, Cambodia and even Indonesia stand by the sideline waiting to undercut China on labour prices.

That is not going to change the fact that over the past decade, billions of dollars of investments have gone into China to ensure that every company looking for a low cost manufacturing base has one in there.

The cost of moving away (currently) offsets any advantages of relocating these manufacturing bases and as such, with recent increases in costs, companies will have to bear the brunt of it, if not able to pass on to consumers or end customers.

However, for new factories, companies are no longer automatically considering China, and are seriously looking at other countries in the region.

In addition, existing factories in China are forced to absorb higher costs, especially with new expansions as it does not make economic sense to relocate the factory overseas.

Costs And Turnover Are Rising

In June, I visited 16 companies which had manufacturing bases in China, and although revenues are rising, costs are rising, faster.

On average, labour costs have risen 15% over the past year and are forecast to increase by 15% per annum for the foreseeable future.

Although that's fast, it's obviously not fast enough because staff turnover at factories in China is averaging 20-25% per year.

Some factories, mainly smaller ones, according to the companies I met, are experiencing a turnover rate of up to 50%, which is especially acute since the Chinese New Year.

Depending on which industries, materials costs have risen by an average of 10-30%. With higher oil price and freight rates, transportation costs have also risen 5-15%.

Obviously the appreciating currency will also play a role, with China's renminbi having appreciated by 4.8% over the past 12 months.

With these kinds of statistics, it is enough to put off any corporate planning manager or business owner from considering locating their production base in China.

Now material and transportation costs are normally a variable that is not easily controlled, as such, labour costs (and proximity to end customer) is probably one of the main factors that will determine relocation.

In fact, after recent cost rises, one of my investors, who has a production facility in China and Thailand noted that if it hadn't been for the Thai baht appreciation, his cost of production in China and Thailand wouldn't have been that different.

With expected continuing appreciation of the renminbi, that should equalise soon.

The Bottomless Pool

According to latest estimates, there are 1.3 billion people in China, and an estimated 758m people of working age. However, the reality is that is not enough. The Chinese think tanks are predicting that there is:-

:: Negligible 0.4% growth in workforce over the next three years

:: Not enough workers (relative to demand) by 2010

:: Zero growth (in absolute numbers) by 201

:: To shrink by 2021

Of the estimated migrant pool of workers, there are only an estimated 52m compared with initial estimates of 100-150m.

So where have these workers gone? Well, they have stayed at home because there are now more jobs back home.

There are many more jobs available now, including in agriculture because farm prices have continued to rise and some families prefer to have their only child working closer to home.

The one child policy has been very successful in slowing China's population growth, as there are now fewer babies making fewer babies.

In addition, because of the tendency for chinese families to favour sons, through various methods of unnatural selection, the ratio of boys to girls in China has risen to 114 boys for every 100 girls at the end of 2005.

In some areas of China, like Guangdong and Hainan, where the practise has been rife, unofficial estimates are close to 130 boys for every 100 girls.

For delicate manufacturing processes, industries in general prefer women from ages of 20-30 years old, something that China is seeing less of every year.

The Next Investment Boom
Like it or not, globalisation is here to stay. Consequently, I believe the outsourcing trend will not only continue but will pick up pace.

If one firm has already started to outsource, it's inevitable competitors will follow.

Hence, if a Chinese factory is getting as competitive as a Thai or Indonesian factory, why not go with a Thai or Indonesian factory, which may only have a worker turnover rate of less than 10% and which does not have the wage inflation the Chinese factories are currently facing.

Still, the world needs a low cost production base somewhere, and if it's not going to be China, then it has to be somewhere else.

If Not China, Where Next?

Vietnam has been touted as the next best location, however, if we look at the base of potential worker pool, we can see that not only Vietnam has a pool of young workers but in fact other countries in southeast Asia as well as most of the countries on the Indian continent have a large population weighted towards the younger generation.

A pool of available labour force alone doesn't make a good workforce, as regulations, attitudes and aptitude are just as important.

Going forward, I believe that the Association of Southeast Asian Nations (ASEAN) will not only be considered a viable alternative to China as a low cost manufacturing base, but will also be seen as a good potential base to sell into China.

With the recent signing of the China-ASEAN free trade agreement, goods manufactured in ASEAN will only be subject to a 5% Chinese duty (and vice versa), making ASEAN a potentially attractive base to export from.

Corporate and Social Responsibilites

Unfortunately, not everyone has the same opportunities as you and me.

There are still children who will probably never make it even to a level where they can be accepted for work in manufacturing industries.

In some cases, these children are taken advantage of in so called "sweat shops" or quite often end up in less desirable professions, including blackmarket activities.

I am pleased to say that after our inaugural board of directors' meeting, we have agreed to allocate 2.5bp of our annual management fee to causes which we believe in. This will include providing shelters and school facilities for less fortunate children in the Indochina region as well as activities to help neutralise our Carbon footprint.

Towering Ambition: The Rebirth Of Dubai

I recently travelled to Dubai to do some due diligence on one of our recent investments - an interior designer/outfitter.

The company specialises in large-scale commercial and residential developments in Malaysia, India and the Middle East.

Now, I'm normally very sceptical of a firm whose business comes more from overseas markets than its own domestic market, but the valuations on this company were so compelling that I decided to take a plunge and have a look at its biggest potential market, Dubai.

I do admit I have always been intrigued by the Palm Trilogy project in Dubai and jumped at a chance to view it from the inside. The person whose brainchild this project was is either a mad genius or a visionary and, given the success of the projects so far, it would seem to be the latter.

The Sheikh of Dubai, Mohammed bin Rashid Al Maktoum, seems reverred by the population, not surprising given the prosperity and the vision he has brought to the region.

Dubai is a city in which total expected investments for both private and public sectors over the next few years will probably equal the investment budget for the whole of ASEAN (Association of South East Asian Nations).

The last time I was in Dubai was pre the Palm project. I don't recognise it now, and I'm pretty sure I won't recognise it in two years time.

A purported quarter of the cranes in the world are currently in Dubai. The city is one big construction site.

I met the Dubai Chamber of Commerce, and they outlined their 30-year plan. Frankly these guys seem to have their act together.

If you think all of this is funded by oil money, well it probably is. However, Dubai no longer has much oil, in fact only 7% of Dubai's 2006 GDP came from oil revenue.

Still, although not much oil factors in the P&L anymore, the balance sheet was probably built from oil revenues.

The highlight of the trip was a visit up the trunk of the Palm Jumeirah to the tip of the Palm to see the Atlantis Hotel, a five star hotel and theme park development, which our company was outfitting the interior of.

Some 70% of all interior fittings, including the plaster walls, carvings and cabinets will be manufactured in Malaysia, though most of the material is likely to be imported, such as Italian leather and marble.

Because of its track record, Emaar, one of the two largest developers in Dubai, awarded this company a follow-on project, to outfit the Burj Dubai Shopping Mall and Hotel.

The mall, when completed, will be the largest in the world, and will be next to the Burj Dubai Tower, which last week became the World's tallest building (although the total number of floors is still a well-kept secret).

Thoughts of overheating, unbelievable projects and "who's going to buy this?" flashed in my mind. However, I'm a small minded kind of guy and not used to thinking big thoughts.

The masterplan for Dubai is not to build an isolated "integrated resort", but an integrated financial, commercial and holiday destination. The biggest "build it and they will come" scheme on the face of the planet.

To cater for an expected increase of the population from 5-6m currently to 9-10m by 2015, will no doubt require substantial investments, including a new airport big enough to support a capacity of 120m visitors; a 55 station Mass Rail Transport system; a total healthcare system; power plants to power everything and the list goes on.

The number of hotel rooms is expected to double from 31,580 rooms to 75,000 rooms by then, or the equvialent of around 200 more hotels.

In case you think there's an oversupply, the average occupancy rate for Dubai hotels in 2006 was 85%.

However, Dubai is not building any particular part first, but everything at once, the first phase of which is targeted to finish by end 2009.

That's a logistical and construction nightmare and fantasy all rolled in one.

For those companies that succesfully manage this process, the rewards are huge. For those that fail, the costs are crippling. Not only are penalty costs high, but so are running costs, given that everything from the nails to the labour force are imported.

Finally, I would like to leave you with thoughts on the most extravagant project I saw in Dubai, the new Dubai Racecourse Masterplan.

Interested investors can buy residential properties which are connected by an intercity canal network allowing them to drive their motor yacht either to the sea or to see the races at the new fully air-conditioned horse racecourse!

However, if you're interested in buying a unit, don't hold your breath. Phase I, expected to be completed by 2009 is already sold out, so you'll have to wait for Phase II!

In the meantime, I suppose you can order your yacht.

Vietnam – The Birth of Capitalism

Life is tough at the bottom, especially if you are the world’s lowest cost producer. A claim that will last until the next country undercuts you. And there is no shortage of countries lining up to do so. Over the last few years, China had been widely touted as the lowest cost producer in the world. I remember seeing several broker reports, including one titled, “What if China was the lowest cost producer of everything?” That claim didn’t last too long though. As the number of factories in a certain location within China rose, labour shortages and high turnover rate inflated wages quickly. This was compounded by China’s strict (but necessary) domestic migration policies (to stop half its population potentially descending into cities and industrialized zones).

However, let’s not forget that although Vietnam has a sizable population (around 86m people at last count), it is still only the size of a large province in China. There are still significant hurdles to overcome in Vietnam, not in the least of which will be infrastructure bottlenecks, which are already starting to appear, at this early stage of its development. Having said that, Vietnam also has some potentially unique opportunities, not only because of the rapid pace of liberalization that it is undergoing but also because of the demographics of the population, which even by Asian standards, is extremely skewed towards the younger age. I noted that in the evenings, everywhere you looked, there were wedding dinners. So, when I think Singapore, I think private bankers haven. Perhaps for Vietnam, it will be wedding planners heaven.

This potentially amazing macro story does not seem to have been missed by the markets and the astounding amount of money chasing the limited ways to play Vietnam has resulted in an even more astounding performance in the stockmarket, which was up 146% in 2006 and 40% for January alone!

With a market capitalization of only US$15bn, the Vietnamese stockmarket may not necessarily be the best way to play the rapidly growing economy, especially as the average local investor has little understanding of valuations. My meetings with local brokers, including one that transacts more than 60% of the foreign volume in the Vietnamese stockmarket, yielded little beyond “more buyers than sellers” and the fact that investors are willing to pay higher prices even now.

Still, share ownership levels are impressive, with already close to 150,000 accounts (compared to Thailand’s 100,000 accounts but of which less than half are active), largely driven by the government’s privatization push, which is putting share ownership into the workers’ hands (aka Maggie Thatcher style) and creating awareness of the stockmarket (albeit in a potentially risky and dangerous manner given little education on valuing companies) at an early stage. However, some of the larger privatizations remain tricky, with limited domestic liquidity and foreign participation, and consequently may be more restricted, compared to what we have seen recently over the past twelve months. “Blue chips” (a definition that is loosely applied given less than a couple of years of track record for some of the larger companies) are trading at heady valuations, with the largest private commercial bank, recently listed, trading at 36x FY07 PER and 8.4x PBV. Although net profit is forecast to grow at 73% over next two years, EPS will be shrinking at an almost frightening rate of -19% over the same period due to increasing capital required to fund the growth.

Credit quality, albeit furthest from anyone’s mind currently, over the longer term is likely to become a huge potential issue. Recent moves by some banks to allow credit approval authority to be extended to branch managers, in order to promote stronger loan growth, is not necessarily a risky move, assuming the right controls and credit approval processes are in place. However, when it comes on the back of certain “stories” we hear, such as bank managers taking a commission of up to 10% of loans extended, we can’t help but feel some déjà vu, some nostalgia from Thai banks’ pre-crisis lending practices. Investors chasing after growth (especially if it is associated with Vietnam, or even China for that matter) are so willing to pay a premium for that growth that all risks are discounted to an almost non-existent level. (Does that remind you of the dot com boom anyone?) The perennial assumption that the one or two steps back is not going to matter much in the five steps forward scenario. Looking at the stockmarket though, it seems like most investors there are factoring in the ten steps forward scenario with no steps back…

Growth is only one aspect of the Vietnam story. How to continue to grow at the neck breaking pace is another potentially more important question, one not focused on much by investors. One thing I noticed was that there all roads were basically two lane or four lane roads at most. Given the rapid industrialization going on, there’s no doubt in my mind that the traffic is only going to get worse. The picture below for a two lane road going in and out of Ho Chi Minh is a frequent scene. Guess what will happen when the locals start having enough money to buy cars. The first thing I would recommend is for them to put some traffic lights into all their crossroads. I thought driving in China would be a nightmare, but that was until I sat in a car in Ho Chi Minh.

The bottleneck at the ports could get even worse. Demand is estimated to rise from 2.5m TEU currently to 6m TEU within the next five years. However, with estimated capacity of only around 1.5m TEU currently, demand already exceeds capacity. Current excess demand is being handled by the military/Navy port but that’s only a temporary solution. Part of the problem is that required infrastructure spending over the next few years is estimated to amount to close to US$145bn with Vietnamese government looking to fund less than 1% of that. This means huge opportunities for private sector funded projects, and also part of the reason for the huge privatization drive that we are now seeing throughout Vietnam, some of which is trickling through in the stockmarket.

The government not only realizes that it will require enormous private funding to build some of these infrastructure projects (meaning a myriad of direct investment opportunities) but will also require private sector help in providing jobs for the 1.5m people enter the job market every year. With each job provided by the state sector costing US$20,000 versus US$1,000 in the private sector, the Vietnamese government cannot afford not to privatize. Other bottlenecks that will surely crop up include the capacity of the existing airport, roads and expressways not only to ports but also within the city itself, some form of mass transport system and probably most importantly, the legal system.

One of the most impressive aspects of capitalism as driven by social principles is the evolution of the agricultural sector. Vietnam is currently one of few countries in Asia which is a net exporter of food. In a period of less than 10-15 years, Vietnam has become one of the largest producers in the world of rice, cashew nuts, pepper, coffee and in the future, potentially rubber.

Part of the reason for this is that a substantial portion of crop planting in a particular area is initially government designated. Once an area is designated for certain crops, the government divide and allocate plots of lands within that area to different farmers, who in effect ‘manage’ their designated plot with a profit sharing arrangement with the government (in effect paying ‘rent’ for the land). As such, what we see is an unprecedented scale of coordinated farming set by socialistic needs but driven by capitalistic principles (farmers are incentivised to maximize yield for their particular plot given profit sharing arrangement).

The above combination of factors does indeed provide a unique set of investment opportunities, particularly in direct investments given the lack of public funding for the majority of the designated infrastructure spending that is desperately needed. The stockmarket remains the easiest channel for most investors to play this growth opportunity, and given the lack of depth (and education in the finer points of valuations for local investors), pricing for most investable stocks remain lofty. Although we will continue to explore investment opportunities in Vietnam, helped somewhat by our proximity, our investment criteria (as with China stocks) is likely to screen out most investable stocks in the market. We are in the process of opening an account in Vietnam and obtaining our identification code to trade in the stockmarket but frankly, at this juncture, we’ll probably be watching from the sidelines for a while longer.

Thailand, despite many missteps, mismanagement and just general incompetence (largely due to political antics) has always been able to meander through its problems, partly because geographically, Thailand is well positioned as a hub (which is why Thai Airways continues to scrape through despite being one of the most poorly managed airlines around) and partly because it really is not a bad place to go to for your holidays. However, if Thailand doesn’t watch out, it might just start seeing a serious challenger in its next door neighbour.

Biggest supporters of US$ starting to lose faith?
On a separate note, the Malaysian government recently announced that it was starting to diversify some of its US$80bn foreign reserves away from US$. Asian central banks have never been particularly adventurous with their cash piles of US$ (excepting Singapore) but this recent move comes on the back of murmurings from other Asian Central Bankers, particularly the Chinese and Japanese, both of whom have denied any intention to seriously consider diversifying their investments. Still, with continuing weakness of the US$ expected, the pain tolerance for the slower accumulators of foreign exchange reserves (particularly the ASEAN countries) are likely to be lower and consequently, may be the first group to look to diversify. Given that our portfolio is positioned largely to benefit from weaker US$, we would be unlocking the bolt if we could, but the Thai government just doesn’t seem to be playing ball. Still, wouldn’t want to be standing in front of the door when the rush does start.

Skyhigh Exuberance

Euphoria remains high
As Asian markets ended the year with a bang (some more lethal than others, see Thailand) with some markets posting all time highs, and with strategists and analysts from the sell side generally being bullish about 2007, I can’t help but feel cautious about exuberance in the markets. Part of the reason is perhaps the fact that I’m based mainly in Bangkok, which is not exactly the centre of booming Asia at this point in time, and that sort of brings one back to reality. Just open up the Asian Wall Street Journal’s Year-End Review of Markets and Finance and the headline says it all “Can the party get even better?”, which is under a picture showing Investment Bankers ready to have a feast in 2007.

Having been on the sell side for more than a decade, I have had the axiom pounded into my brain “Bullish Brokers get the Business”. A self evident truth upon which other knowledge must rest, and from which other knowledge is built up. With an estimated more than 90% of funds invested in Asia being long only (of which the remainder has the ability to short but is probably long biased), the inability to short (more than probably at best a quarter of the stocks in less than half the markets in Asia) and it’s not difficult to see why it just doesn’t pay to be a bear in Asia (on the sell side at any rate). Richard Russell succinctly puts it, “Conventional market wisdom tells us that "the higher the rise, the bigger the fall." Well, the markets have been on the up-escalator ever since October, 2002, and nothing bad has happened yet. Furthermore, the universal opinion of the experts is that nothing bad is going to happen in 2007. In fact, from what I gather, the experts believe that nothing bad is ever going to happen -- at least not in this lifetime.” He was talking about the US stock market, but then, he could be talking about a few other markets in Asia from what I can see. Investors tend to forget…fast.

For a value fund, it’s a tough time to be picking stocks, for we are the “turtles” of any race and it’s tough to see the way when the “hares” are rushing past. Still I’m an optimist and the good thing is when the “hare” is rushing past, inevitably, it will not find the diamonds hidden in the rough. As such, we will continue to search far and wide in 2007 for similar types of gems to those we dug up in 2006.

I thought it would be appropriate to round up some of my thoughts for markets in Asia and what we could expect to see in 2007 and what we are likely to be focusing on in 2007.

ASEAN markets
I believe the ASEAN markets remains undervalued relative to other emerging markets, despite the fact that Indonesia, Vietnam and Philippines have been probably three of the top five best performing markets in Asia in 2006. However, I would not be focusing on the blue chip stocks in ASEAN as I believe they are not only expensive but are also over-owned. For larger funds to get exposure to these smaller markets, they tend to focus on the top few stocks, which mean average valuations for these stocks tend to be higher than what you would pay if you went for ‘second tier’ stocks. Given analyst resources in these markets (which tend to be a lot less than the larger markets in Asia), it’s not surprising that only the top quartile of the number of companies listed in these markets are covered, providing significant opportunity for those willing to do some deeper digging.

Despite the relative resilience of the fund to events in Thailand so far, we are a little wary of recent events in Thailand. It just goes to show even the more stable countries can ‘blow up’ in a short period of time, and I suppose that’s why risk premiums for these markets tend to be higher than more developed markets. For 2007, we will probably look to switch rather than continue to increase our exposure to both Thailand and Indonesia in order to reduce country risk for the portfolio. I believe there is more room to invest into Malaysia and Philippines and will be doing more digging there. We have already established some initial headway into Vietnam and will be sniffing around there in 2007. For the latter, I believe there is currently too much money chasing after a very small pie (the Vietnamese stock market) and that risk premiums are not being reflected if we compare the valuations being paid for in Vietnam versus the rest of ASEAN. Still there is no harm looking, but the better valued investments are probably private, and that will take a lot more work.

As for Thailand, after a series of mishaps (although unrelated - as far as I know anyway), investors are beginning to have doubts about Thailand as a laggard play (relative to rest of Asia, having been the worse performer now for almost two years running). I myself continue to believe the long term potentials of the Thai market, it’s just a shame that it’s been run by a small group of greedy, power hungry individuals (no names) with more interest in lining their own pockets than to further the development of the country. This issue unfortunately does not have a short term solution because the pro democracy advocates (generally Bangkokians), who are so keen to see everyone get their right to vote, also happens to be the ones who are most unhappy at seeing who gets voted in and will happily support a non democratic removal of such parties, for which the age old adage for Thai democracy still stands true, “The provinces votes into power a Prime Minister which Bangkok will inevitably kick out”.

Until more investment is put into education, this will not change and is also the fundamental issue that the Junta is facing in drafting a new constitution that will both satisfy Democracy advocates and those that want to see less corrupt politicians in power. The fact is that the previous constitution was perfectly workable except that it did not factor in the ability of someone who was rich enough to bypass its’ controls (in other words, it was not written with someone like Thaksin in mind). Consequently, the only other option is to appoint a Prime Minister and Cabinet, something which would not only make the Junta look no better than the previous government but would also probably cause some major dissent amongst the populous. On the other hand, if you polled voters even now, one of the more admired and desirable Prime Ministers from the past is probably still Anand Panyarachun, whom, as it happens, was an appointed Prime Minister. Damned if you do, damned if you don’t.

It will be interesting to see how the Junta will try to meander from promising full Democratic elections at the end of 2007 to promising a non (or perhaps less?) corrupt appointed Prime Minister and Cabinet. Although the current appointed Cabinet was actually quite well respected to start with, the recent misstep over Capital controls from the BOT (for which no one has yet resigned to take responsibility), the lack of activity (due mainly to the lack of experience in dealing with government matters from new appointees) and the rapid appointments of soldiers to boards and positions of power has somewhat toned down initial euphoria and support for the coup and the Junta. At any rate, further violence, disruptions and shuffles cannot be ruled out as both Junta and pro-Thaksin camps manoeuvre to negotiate a ‘settlement’, with both sides flexing their muscles to improve their leverage. In meantime, it’s probably not going to be too pretty for the Thai stock market.


Korea – Derating to continue?
Korea is another seemingly darling turned nightmare market for foreign investors with recent rulings over Lone Star’s Investment in Korea Exchange Bank (004940 KS) signaling potentially a more nationalistic and patriotic stance from the government. Foreigners have been exiting this market faster than you can say, well, Korea Exchange Bank. In fact, since the beginning of the year, foreign investors have net sold close to US$12bn worth of stock, the only stock market (in Asia) to see net outflow in 2006. Nevertheless, from my visits, Korean companies are, in my opinion, on the leading edge of manufacturing in Asia, and are difficult to ignore for pure absolute value. It’s just a shame that corporate governance and minority shareholder treatment is probably still one of the weakest in Asia. Still, I believe we will probably be doing a lot more work in Korea in 2007. I always find that the best value is quite often in places where investors are exiting (especially in a rush), not where they are heading to.

HK/China (and India) – Irrational exuberance?
As I had indicated from my previous memoirs, China and India are difficult markets to ignore given the enormous growth potential for both markets. In fact, our main gripe with China and Indian stocks are not the growth prospects but the valuations. In order to get exposure, we have to pay prices which will take 2-3 years to bring into reasonable levels, assuming current growth rate is sustained, something which is not only against the fund’s investment strategy but would also probably keep me awake at night. Still, that won’t keep us from digging, but don’t hold your breath.

Taiwan – Best Value in Asia?
Taiwan, at this juncture, given average PER valuations of 13x FY07 earnings against average EPS growth of 20% and dividend yield of 4.2% (vs 3.2% for Asia), is probably one of the best value markets in Asia. The only problem is that political risk for Taiwan remains high and a large proportion of the listed companies are technology related. Still, that’s not enough to put us off, and we’re probably going to be all over Taiwan in 2007.

I believe as we see a strong ASEAN growth story pan out, earnings momentum and revisions are likely to follow, together with more M&As, which should bode well for our portfolio, given our close to 87% exposure to the ASEAN market. However, 2007 will be a challenging year in my opinion and given where markets are now relative to 2006, it would not be a surprise to see a couple of repeats of May 2006 performances for Asian markets in 2007.

With close to 270 companies visited in 2006, we had great coverage over the past year and were able to unearth some real gems. Despite the strong performances in Asian markets so far, I continue to remain optimistic on our prospects for uncovering more under-researched gems as the rush for beta to play the momentum will leave a lot of ‘value’ stocks untouched, largely because liquidity is generally lower, market capitalization is smaller or purely because growth is not as sexy as the higher rate (but much more expensive) growth stocks.

I would like to leave you with a summary of our “stock recommendation sheet” (back by popular demand). I always like to think of the fund as an investment holding company, which incidentally, holds not only some of the most well known brands in Asia, but also globally. NTAsian provides an investor with unparalleled exposure to rising affluence and domestic consumption in Asia. At 9x FY07 and 7.8x FY08 earnings, NTAsian (NTASIAN KY Equity) is not only trading at close to a 40% discount to average Asian market PER valuations but is also growing close to 3-4x faster versus the Asian markets, in terms of EPS growth. You can’t find better value than that!

Another Global Warming Plug
With reports coming in now that China will probably exceed originally forecast emissions within half the time that was originally targeted (or potentially equal US emissions within the next 10 years), and that most countries, even those that signed the Kyoto Treaty, are unlikely to meet their emission targets, it is a constant reminder that there is a price to growth that is not purely monetary. For us, being on the frontier of investing in Asia, we feel strongly that we have a social responsibility to ensure that the companies we are investing in are fully compliant or working towards these goals and in 2007, will be working hard with our investments to meet these goals.

If you were one of our fund subscribers, you should have received the book, “An Inconvenient Truth” from us. We hope you enjoy it. It’s not totally accurate or scientific (after all, it’s authored by a politician!), but it’s an excellent introduction to one of the greatest problems that we are potentially facing as the human race. For those whose interests have been piqued and would like to learn more, I highly recommend “The Weather Makers: How Man Is Changing the Climate and What It Means for Life on Earth” by Tim Flannery. This is a little more technical but a superb book highlighting this issue and why this is a matter that will impact our generation. In the end, a point the author makes is most prescient, if you thought you had a disease which may or may not be fatal, but the doctor recommended you to take some medicine anyway as insurance, you probably wouldn’t think twice about doing something about it. Scientists may never fully be able to prove of the link between human caused emissions and global warming until it is too late, but why should we not take prudent steps now to avoid it, rather than finding out that they were right only when it is too late to do something about it.

Until next month. Happy New Year everyone!