Asia's Growth Raising Prospects In Smaller Markets

• By Cris Sholto Heaton
• On 2:01 pm EDT, Friday September 18, 2009

(Editor's note:The following is an edited excerpt of a story that originally ran on IndexUniverse.com's sister European site.)

In the 1990s, investors couldn’t get enough of Asia’s small, fast-growing economies. The flood of money they pumped into markets that simply weren’t ready to handle it resulted in an enormous bubble, followed by a devastating crash in 1997-1998.

Today, all that has changed. China and India are the hot stories, while the rest of the region doesn’t even feature on the radar for many investors. But that could well be a mistake; there is still a good investment case for Asia’s smaller, less fashionable economies.

These smaller countries complement China and India. They should benefit from the rise of their larger neighbours and the region as a whole, while offering exposure to different themes and sectors. More importantly, many of them are available to investors more cheaply than their hotter peers.

Considering Vietnam

The market that is getting the most attention at the moment is Vietnam, where the bull case can be summed up as ‘Vietnam is now where China was two decades ago’. It is a poor country at a low level of development but it has good fundamentals:a young, relatively well educated workforce (given the country’s level of development), low labour costs, abundant natural resources and a steady transition from communism towards a form of capitalism. Vietnam is one of the countries filling the low-cost manufacturing niche for goods such as clothes and furniture abandoned by the Chinese coastal provinces as they move on up the value chain.

In the U.S., the first pure-play exchange-traded product launched in August:the Market Vectors Vietnam ETF (NYSEArca:VNM - News). You can read more about it here.

There is also one available to investors in Europe, the db x-trackers FTSE Vietnam. This fund's index tracks all the companies in the Vietnamese market that have sufficient availability to foreigners to be investable (Vietnam imposes limits on foreign stakes in companies). It currently includes 27 stocks:raw materials (in which national oil company PetroVietnam predominates) is the largest sector, accounting for a quarter of the basket, followed by financials (mostly real estate). There’s also reasonable exposure to sectors such as consumer goods.

The main omission is the absence of any banks in the financials basket, but this is unavoidable given that there is insufficient free float available to foreigners to make them eligible.

Looking At Malaysia

Nearby Malaysia is a very different type of economy. It went through a period of rapid development in the eighties and nineties, culminating in the region-wide bubble and crash that was the Asian crisis of 1997-1998. Since then, it has failed to make as much progress as it should have; it remains a middle-income country that is steadily losing mid-end manufacturing work in sectors such as electronics to China. The situation isn’t helped by the country’s poorly implemented positive discrimination policies in favour of the poorer majority Malays (at the expense of richer Chinese and Indian groups).

However, things in Malaysia could be about to improve. The electorate has become increasingly disgruntled with the Barisan Nasional coalition that has held power since independence, forcing the government to come up with some new ideas after several years of stagnation. New prime minister Najib Razak recently announced a number of measures to liberalise the financial sector, with the goal of growing the service-based economy; in particular, there is a long-standing aim to make Kuala Lumpur a key hub for the fast-growing Islamic finance industry. Closer co-operation with neighbour and long-time rival Singapore (which was briefly a part of Malaysia after independence) is a possibility and could benefit both countries.

There’s no guarantee that Malaysia will get back on track, but it makes for a potentially interesting turnaround story. Lyxor offers a tracker for the MSCI Malaysia index, which looks reasonably balanced; financials account for around 30% of the index, followed by industrials (20%), consumer staples (15%) and consumer discretionary (13%). The product is swap-based, pays dividends annually, and has a TER of 0.65%.

In the U.S., investors can focus on the country through the iShares MSCI Malaysia Index (NYSEArca:EWM - News).

An Even Wealthier, More Advanced Economy

Malaysia isn’t the only Asian country that needs to undergo some major changes if it wants to prosper in the next few years.

Taiwan is a wealthier, more advanced economy than Malaysia and is a key centre of the global technology industry. But the local economy has also failed to make much progress in recent years as manufacturing has shifted to China and investment – both from foreigners and Taiwanese companies and individuals – has tended to flow there as well. The island’s difficult relations with China – which views it as a renegade province – haven’t helped; caps on investment between the two countries and the absence of direct flights to the mainland mean that it has not benefited from the rise of its neighbour as much as it might have.

But, once again, the situation is changing. Ties have begun to improve following the election of new president Ma Ying-jeou earlier this year on a more pro-Beijing platform. Investment restrictions have been relaxed and direct flights have commenced. As long as this rapprochement continues, Taiwan’s prospects could improve dramatically. The island could evolve into an offshore centre in electronics, specialising in research and development, and also potentially into new sectors such as biotech, working with manufacturing facilities on the mainland.

The Chinese government is likely to direct investment into Taiwan in an effort to cement closer ties as part of its goal of eventual reunification. Foreign firms are also likely to view Taiwan as a more viable place to locate regional headquarters as it becomes less isolated, while wealthy Taiwanese may repatriate money held abroad to invest in the island.

European investors have access to two indices covering the Taiwanese market. The most widely used is the MSCI Taiwan. Inevitably, given the tech-heavy nature of the Taiwanese economy, the index is somewhat lopsided; technology comprises more than 55% of the basket, with financials a distant second at 15%. However, this probably isn’t an enormous problem given that tech will be a crucial part of any Taiwanese renaissance.

In the U.S., investors can tap direct exposure into the country through the iShares MSCI Taiwan Index (NYSEArca:EWT - News).

Hong Kong Also Making Gains

Finally, the ETF universe includes one other small Asian economy:In Europe, a Lyxor tracker for the Hong Kong Hang Seng benchmark. Meanwhile, in the U.S., there's the iShares MSCI Hong Kong Index (NYSEArca:EWH - News).

Hong Kong should profit from the rise of China and is most likely to do so through its financial, real estate and services sector. In this respect, while the 42-member Hang Seng seems quite an unbalanced index (financials, including real estate, account for 60% of the basket), it is a fair representation of the overall shape and prospects of the Hong Kong economy. However, investors should note that the number of Hong Kong-listed mainland Chinese firms in the Hang Seng means that there could be significant overlap between this fund and any China trackers they may already own.

There are other interesting stories among the smaller Asian economies but limited choice in the European ETF market. Lyxor recently delisted its MSCI Thailand tracker due to lack of interest; investors who want access to the index now only have the option of a US-listed iShares ETF.

Indonesia has started to appear on investors’ agendas as markets wake up to the potential of a large, early-stage economy of 250 million people, but so far the sole dedicated ETF is also listed only in the U.S. That's the Market Vectors Indonesia Index (NYSEArca:IDX - News). You can read more about it here.

Even more bafflingly, there is no European ETF for Singapore – a developed, well-established market and key regional hub, which should benefit from the rise of its neighbours – although there are both US- and Asia-listed trackers. Investors can utilize the iShares MSCI Singapore Index (NYSEArca:EWS - News).

And there’s no product listed anywhere in the world for the Philippines, obliging investors who want an easily-accessed proxy to use the American Depositary Receipt of Philippines Long Distance Telephone (which accounts for around 25% of the local market) as an imperfect substitute.

One note:At least one U.S. provider, Global X Management, has filed to offer an ETF tracking the Philippines market. It also has other Asian-specific funds in its pipeline. (See related story here.)

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Cris Sholto Heaton is a freelance investment writer who has specialised in Asian financial and business issues for the past five years. Prior to that, he worked in financial services consultancy for PricewaterhouseCoopers and Lane Clark & Peacock. He holds degrees in finance from Birkbeck College, University of London and mathematics from the University of Durham.

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