Whenever a new market is spotted by adventurous global investors, a simplistic equation is usually trotted out: top-line growth in gross domestic product (GDP) = huge stock market potential.
Now, there may appear to be a relationship between the two at varying points in time – especially during growth phases within stock markets. But, over the long term, the relationship is tenuous. Academic studies show that the best returns over the very long term come from investing in the most boring countries with anaemic growth prospects – Belgium might be a better bet than China.
However, I think there is a useful formula for judging the potential of a new market: it’s what I call the “Hugh Young 10” test.
Hugh Young is Aberdeen’s renowned Asian fund manager, who runs an army of top-rated open-ended investment companies (Oeics) and investment trusts, in which I regularly invest.
His test for identifying a country with promise is to ask whether it has 10 big companies that he’d like to own in his portfolio – a motivation prompted in part by regulations requiring EU-listed funds to be diversified across at least 10 companies.
Young’s selection process involves a top-down analysis of the macro-economic framework, but I reckon he’s more interested in a bottom-up assessment of the companies themselves. He appears to favour old-fashioned qualities: transparency, clear accounting rules and some value in the share price. In particular, he seems to be a fan of locally-listed subsidiaries of UK-listed companies, such as Unilever and BAT. If Young and his colleagues can list 10 solid companies in one Asian country, then that country has “made it” – and might even merit its own separate fund.
So, which emerging markets pass the test?
Vietnam abjectly fails, according to Young. He doesn’t deny that the nation has enormous potential based on its status as “Little China”. It’s just that apart from one blue-chip local stock – a dairy – he can’t name any holdings that he’d want. The Philippines boasts a few companies and Sri Lanka has five or six, says Young, but nowhere near 10.
In fact, only one relatively new market passes his test: Indonesia.
Aberdeen already has a specialist closed-ended Indonesia fund in the US, which it inherited from its takeover of Credit Suisse’s asset management business earlier this year. So, over the summer, Young and his team have reshaped the fund’s portfolio, putting the emphasis on reasonably-valued quality companies.
Top holdings now include Unilever Indonesia (guess who owns 85 per cent of this local company?), telecoms outfit Telekomunikasi, cement producer Holcim Indonesia, a bank called OCBC NISP, plus a Jardine Holdings subsidiary called Jardine Cycle and Carriage.
But Aberdeen’s enthusiasm for Indonesia isn’t just because Young can find 10 companies worth investing in. There are obvious top-down factors at work, too. Indonesia, unlike Vietnam, boasts a democratic government under Susilo Bambang Yudhoyono. His government is also benefiting from some long-term secular trends: rapid industrialisation; rising prices for oil, palm oil, metals and agricultural products; increased domestic consumer spending.
Add in a relatively sound financial position – low levels of debt and a declining budget deficit – plus success (so far) in beating militant Islam, and you can see why the MSCI Indonesia index is up 116 per cent in the year to date. That has lifted its 10-year average annual return to 13.7 per cent – beaten only by the likes of Colombia and Brazil among the other emerging markets.
I’d also cite one other crucial factor: resilience. In past years, Indonesia has been beset by tragedies, from tsunamis to terrorist attacks. Yet it has managed to bounce back.
Admittedly, it is still a long way from being the perfect emerging market. Corporate governance may be better than in China, but that’s a low standard! Corruption remains a problem. And equity valuations on the local exchange are frothy: price/earnings ratios are in the high teens.
However, at least there’s the prospect of sustainable long-term growth that is not reliant on monetary easing and low interest rates. It’s also a lot cheaper than buying into China.
Fund Focus
Adventurous investors willing to take a risk on Indonesia don’t have many funds to choose from. Van Eck Global and Market Vectors offer a US-listed exchange traded fund (ETF) but this index tracker doesn’t charge much less than the US-listed Aberdeen Indonesia fund. I’m also wary of using index tracker funds to invest in risky markets, because they tend to buy the most traded local stocks. In the Van Eck ETF, that means big local banks that the Aberdeen fund tends to steer clear of.
I prefer the Aberdeen fund, as it ensures that constituent companies operate western-style rules on corporate governance (hence the stake in the local subsidiary of Unilever). It also has experienced local managers with a tight focus on value for money and transparency. My only disappointment is that it doesn’t have a UK listing.
adventurous@ft.com
