ASIA - Investors from across the world couldn't get enough of Asian markets in recent years but the shine is fast coming off.
The cheap money that has fuelled the rally is nearing its end while the resilient Asian growth story is weakening.
The talk now is of the recovery in the United States and even Europe but that is not to say regional equities are completely off the investment radar.
JP Morgan Asset Management's senior regional fund manager Jeffrey Roskell, who manages the US$4.5 billion (S$5.7 billion) Asia Pacific Income Fund, notes that while Asian equities carry less weight in the fund manager's broad portfolio, there are pockets of opportunities in regional markets.
Q: US and Japanese equities are looking more attractive given their growth stories and investors are responding. Is this diluting the appeal of ASEAN stock markets?
We are underweight on the ASEAN region in terms of our broader portfolio due to concerns over valuation and currency risk.
Currencies in the region have benefited from carry trade for a long time and that carry trade is now unwinding.
To some extent, if you believe US interest rates are in the process of normalising from a very low level, then it's not a bad thing and especially so, when it's a function of an improving economy.
We've hedged a large amount of currency exposure as that's an area of concern.
Given the improving US economy, some investors in the US may repatriate their money but it doesn't cancel out the attractiveness of investing in Asia.
Long-term prospects for Asian equities are good and a diversified portfolio would mean putting part of that in Asia.
Q: Given the widening valuation gap between the US and Asia, shouldn't it make Asian stocks attractive now?
Yes, Asia is looking cheaper than the US and the discount could bring investors back at some point.
We are seeing another round of earning downgrades in Asian equities.
We are still underweight on the cyclical sector as a portfolio of yield stocks should be less volatile.
Over 80 per cent of our equity portfolio consists of those listed in Australia, Hong Kong, Singapore and Thailand, which have a lot of companies paying high dividends from earnings.
Conversely, we have a small percentage of equities in India and South Korea where companies' dividend pay-out ratio is relatively low.
We are underweight on China, Taiwan and India as these are the most volatile markets in the region.
Q: Given the imminent tapering of the US Federal Reserve's stimulus plan, what should investors do?
The kind of equities you want to own in a rising interest rate environment is different as opposed to when bond yields are falling (in a low interest rate environment).
Over the past year, the portfolio of our Asia Pacific Income Fund has focused on dividend stocks like utilities, toll operators, real estate investment trusts and telecommunications.
It made up some 70 per cent of our portfolio. But in some cases, they've become a little expensive.
The other grouping is more cyclical and they are slightly cheaper, like banks. As of end July, 53 per cent of our equities were in more cyclical stocks and half of that was in banks and other financials like stockbrokers, insurance and stock exchanges.
The other half was in industrial, chemical and technology stocks.
We didn't do this because of the US Fed's announcement in May (about stimulus tapering) but we did it because of their valuation.
So we are not explicitly setting up our portfolio for rising or falling rates but balancing it.
Q: Is the hunt for yield that has had investors fixated for the past year or so still on?
Quite possibly, we've seen an overreaction in the past few months on expectations of a change in the US Fed policy.
Investors need to remember that short-term rates are going to stay low for a while. Cash is still a pretty poor place to hide over the next three years.
If we move further up the risk curve by owning riskier or lowerrated bonds and earn a 5.5 per cent yield, it's a risk worth taking. It's not without risk but it's a reasonable prospective return.
Investors shouldn't necessarily be frightened by rising rates if it's accompanied by an improving economy. One can always include stocks in the defensive buckets that are getting more interesting again.
Q: Is the rotation from bonds to equities still persisting?
We are underweight on bonds.
When you're getting about 2 per cent from owning Asian high-grade bonds, we'd rather take that money out and put it into relatively high-quality equities yielding 5 per cent or more.
Equities are more risky but their returns are consistently more.
Our fund has consistently comprised about 65 per cent equities, low 30 per cent in bonds and a little bit of cash.
Q: Chinese equities have been battered and some say this is exaggerated on concerns of slower growth. Your view? We own some pretty defensive businesses in China in terms of equities such as toll roads and telco stocks.
Oil and gas refining firms and banks are trading on low multiples with decent dividend yield.
Our job is to take risk judiciously, not to eliminate risk. If you want to eliminate risk, you tend to pay quite high valuations.
Clearly there are risks in China but by buying less risky stocks, we are getting paid to take that risk.
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