The season’s favoured region

Often investors are amazed to discover, often after the event, that a particular region or country has gone ballistic. So how do you spot the next big region? What are the economic factors to look out for? Where do the experts feel may be the ‘next big thing’? Jo Tura finds out.

The world is a large place, filled with areas to invest in – regions that initally might not have been typical ‘safe’ domestic or developed markets. While good diversification is paramount to avoid falling into the trap of ending up with all your eggs scrambled in the one basket, it’s possible to use a proportion of your portfolio to chase the hot new places and make some extra money out of sticking your neck out.

“The good thing about going into other countries is that it helps diversify your portfolio,” says Greg Smith, managing director of equity research company Fat Prophets. “When some countries are going into a recession others will be coming out of it.” The US, for example, doesn’t look that good at the moment, he notes, while Japan – and maybe even Germany in a couple of years’ time – will be coming out of their recessions.

Turning Japanese

Many investment managers are currently taking a fresh look at Japan, which may be finally coming out of its deflationary period, according to research from Smith’s company. A feature such as the election win by the reforming Liberal Democratic Party can be a good guide to a country really turning around, especially when combined with strong economic back-up. According to Fat Prophets the Nikkei recently hit its highest level since May 2001, GDP growth is faster than had been thought, and the International Monetary Fund has increased its growth forecasts for Japan, citing greater than expected consumer spending.

“Primary for any country is economic growth, but that goes into the mix to make up the big picture,” explains Smith. “In terms of indicators, Japan has suffered a lot of deflation. Now there is sign of prices rising there. Good economic news will lead to a bigger news flow about a particular country, especially when it’s been previously considered to be down and out. You can see somewhere might be a better prospect if you read about foreign investment going back to a region.”

Another example of newsflow pointing to potential investment is illustrated by the Turkey fund, which was launched by emerging markets specialists Charlemagne Capital. The fund was launched at the end of last year to capitalise on growth in the country, which, after some heated negotiation, has just been cleared for EU accession.

Stefan Böttcher, head of portfolio management at Charlemagne Capital said at the time of the launch: “There is no reason to believe Turkey will not enjoy the same results as other convergence countries have had. For example, on 31 March 1994, accession talks began between the EU and Hungary. Between that date and EU entry on 1 May, 2004, the Budapest Index rose by 501 per cent.” So far the theory has held, and the Turkey fund has grown nearly 50 per cent in under a year.

Coming around again

Finding a country experiencing a turnaround from a sticky situation is one of the best ways of making money in global investment according to Gervais Williams, manager of the Gartmore Irish Growth Trust.

Back in June 1995 Williams set up the trust to take advantage of the opportunities in the market, which picked up its ‘Celtic Tiger’ nickname due to the economic boom it went through. “When I set the fund up it was quite a struggle,” says Williams. “Ireland wasn’t the sort of place you’d think of as a high-growth economy and had been the sick man of Europe for a long time.”

Due to a combination of economic and demographic factors, Williams realised that money was to be made. A highly educated English-speaking workforce, regular accounting principles and corporate tax rateswhich would reduce in the future were just a few of the positives, he says. “Everything led to its being a very unusual mix where all the green lights were on. The best money is to be made when you get into a situation that has been disappointing but then gets growth forecast. Valuations are low and you can get in.

“ It’s very difficult now to find that sort of situation: Japan is the only region looking disgustingly cheap at the moment, unless there are places I don’t know about – Romania or elsewhere,” he adds.

Williams is still finding good returns in Ireland at 5–6 per cent, down from the heady highs of 11 per cent or so in 1999, four years after he set his trust up.

BRIC it up and start again

The complex mix of pointers such as those surrounding Ireland in the mid-nineties may not be so easy for the private investor to spot. Thus, investment funds can be a useful way of getting into the hotspots with-out having to do all the work. As Fat Prophets’ Greg Smith puts it: “A collective like an investment or unit trust takes the need to dissect various economies out of your hands”.

Furthermore, funds – with their diversification – can often be the safest way and sometimes the only way of getting into far-flung markets, where it can be difficult for a private investor to invest directly.

Mark Hinton, head of research at Whitechurch Securities, is in favour of leaving the hard work to a reliable sector specialist such as Franklin Templeton’s Mark Mobius. “You can see the reasons behind a fund launch like the BRIC fund, which will invest in Brazil, Russia, India and China,” says Hinton. “From a private investor point of view, you don’t need to be doing research into Slovenia and places like that if you can leave it to someone like Mobius.”

At Skerritts, investment consultant Andrew Merricks jokes that the best thing to do when groups launch a clutch of funds in one region is to get out of it. The risk being that when something is being loaded onto a bandwagon it’s time to get off. Greg Smith agrees with Merricks: “We all remember the tech boom when it seemed every new launch was tech, now it seems that’s happening with mining and resources. There is a fine line between something being a sign that things are getting better and something getting overbought.”

But Merricks says, it takes a long time for the wheels to get turning in a more emerging market, so chances may not yet have been missed. “In historical terms any of these BRIC-type regions are young and underdeveloped,” says Merricks. “If you believe in the bull market and development of China, Russia and Latin America, why not? You can go for the long-term story there.” (On this basis it is worth noting that the best-performing funds of the year so far may yet have some way to go, see Hinton points out that gimmicky, ‘me too’ style fund launches are unlikely in the aftermath of the tech boom: “It’s hard for the private investor to work out what is a gimmick, but you’ve got to do the research. I think the fund groups have realised on the back of the tech boom that it’s not such a great idea to launch just because of a trend, so I haven’t seen too many bad examples of that.”

Don’t believe the hype

It is valuable to know what is behind the hype. James Thompson manages the highly rated Rathbone Global Opportunities fund. Despite all the noise about China and the fact that the country is reforming, he notes that companies aren’t actually growing.

“ I spent two weeks there a short time ago, and I think what we’re continuing to see is value destruction,” he says. “I’m avoiding manufacturing and outsourcing plays – the ones that everyone cites with China – because the competitive advantage has been exploited already. They’ve beaten the Western manufacturers into the ground already and now they’re turning on themselves.”

A question Thompson has been asking is what people believe they would have made on their money, had they invested in China ten years ago. The brutal answer is that you would have lost 75 per cent. “China has actually been one of the worst performing markets in the world over this last year,” says Thompson.

In Thompson’s opinion, the way to play the market is to look for the countries and companies that will profit from providing the raw materials that China needs for its growth. In fact many of the outperforming China and Oriental funds use the more stable Hong Kong and Taiwan markets as the obvious ways of getting into the mainland. Matthew Dobbs, fund manager at Schroders, is using countries such as the above, and Thailand, Singapore and Indonesia for his new Schroder Oriental Fund. “The yield average on theses markets relative to others has risen pretty substantially in the last four or five years,” explains Dobbs.

Dobbs’ biggest holding, forming a quarter of the fund, is Australia, a market that has continued to do well since hitting new highs with its All Ordinaries index last year, but he is finding excellent value in his Asian holdings. “The basic thesis with most of Asia is that the corporate sectors are generating similar returns on equity to most global markets,” he explains. “But they are at a 30 per cent discount to the rest of the world. Of course the region still has its challenges.”

From Russia with love?

The challenges with less developed markets are all important. “In Russia, the market has done very well on the back of the oil price, and the emerging market funds we look at still have attractive values,” says Hinton. “But there is still political risk there and you have scandals like Yukos to watch out for.”

Merricks remembers a catalogue of disaster: “Be careful you don’t limit yourself to emerging markets,” he says. “In some ways you don’t get diversification. If one goes, they all go. Mexico was top in Latin America until the Tequila crisis in 1994. They devalued the peso and that was the trigger for all emerging markets to fall. In 1997 the Thai Baht devalued and Asia fell. In 1998 Russia defaulted on debt and Eastern Europe fell.”

Hinton thinks adventurous investors would be able to invest up to 25 per cent of their portfolios in these areas, with 10 per cent in Japan, for example, and chunks of 5 per cent in three other areas. If it is just ‘fun money’ adds Merricks, sensible investors won’t get attached to their finds. “Put your money in and keep an eye on it. Then, if you make a profit, take it out and put it into something different. Don’t get too attached to it, that’s the mistake a lot of people make.”

Charterhouse Communications

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