The Asian Bull

This article first appeared in the 15 Sept-14 Oct issue of Mutual Fund Insight magazine. It charts the changes and the growth that Asia has witnessed over the years and its relationship with the Western world and what lies in store in the future.

Ayaz Ebrahim
CEO, Asia-Pacific
Halbis Capital Management

A decade ago, when Ayaz Ebrahim was at Crédit Agricole Asset Management, where he spent 11 years, he described his penchant for the HSBC stock (HSBC Holdings PLC) to an American publication. He told the reporter at Barron’s that he liked investing in the large, Hong Kong-based commercial and retail banking conglomerate, for its diversified exposure to Asia.

Interestingly, a few years down the road in 2003, Ebrahim joined HSBC’s asset management business in Asia as the Chief Investment Officer. Upon Halbis’ establishment in 2005, he took over as Chief Executive Officer. Halbis, which manages over $26 billion in assets in Asia, is the active fundamental investment specialist of HSBC Global Asset Management.

Ebrahim is responsible for the fund house’s equity and fixed income investments in Asia, ex-Japan. He is also the lead fund manager for the fund house’s regional equity funds. He speaks to Larissa Fernand on his investment style and his views on Asia.

A few years ago, you had stated that you follow three keys to stock picking in Asia: Throwing away the benchmark, local knowledge and a degree of scepticism. Are benchmarks not crucial to tracking performance?

Benchmarks are definitely useful in the sense that they give an indication of what added value active fund managers can provide. But I do believe that one can get a little too fixated with benchmarks. At the end of the day, companies with a large market cap tend to have a more dominant effect on a benchmark since the latter are constructed based on the free float and are a function of market capitalisation.

What do investors look at when they pick stocks? They look for good, high quality companies that have the potential to deliver a reasonable return over a long period of time. So in that sense, they should not get too fixated with the benchmark composition.

Would not a degree of scepticism be applicable to investing anywhere?

This would certainly apply to many places. To really delve into an issue and understand it well, you must look at it critically. And some degree of scepticism when meeting companies does help. A lot of the companies we meet are trying to do a sell job as well because they want equity investment and want to raise capital. So when you meet these companies, you have to take what they say with a pinch of salt. I am not saying even for one moment that they lie or deliberately mislead, but it is in their best interests to promote their company as positively as possible. And one just needs to look at it critically and conduct the research diligently and make sure everything is consistent.  

You say you would apply a degree of scepticism when investing in Asian companies. Would you hold the same degree of scepticism when investing in, say, the U.S.?

The criteria for stock picking across the globe, in essence, would be the same. But the level of due diligence required on our part would be different in different parts of the world. This is because disclosure requirements may be different in different geographies.

In our experience, the legal and regulatory provisions in the U.S., and in some other developed markets, make the corporates reveal more in-depth information and make relatively higher levels of disclosures than the corporates in Asia.

But have you seen an improvement in transparency over the years that you have been investing in Asia?

Oh definitely. No doubt about it. I have been involved in this area since the late ‘80s. And there have been a lot of positive changes. I think the Asian financial crisis of 1997-98 was a turning point that accelerated the transparency and set in place corporate governance issues. And companies responded as well. Take Korean companies, as an example; earlier there was no requirement for consolidated statements; so one could look at the balance sheet but have no idea of what balance sheet items are sitting in subsidiary companies. But now a lot of changes have been implemented. Corporate governance standards have improved significantly. Another example is making independent directors on boards mandatory. 

You say that the Asian financial crisis was a turning point for companies in Asia. What impact did the last global crisis have?

What took place last year was not really intrinsic to Asia. There was some spillover into Asia because huge financial institutions collapsed and there was a global credit crisis. But this was not an Asian problem, not like the financial crisis of 1997-98. This was a ‘developed economy’ problem.

Initially, there was a view in some quarters that though this was a very serious issue, Asia could be shielded from it. However, those quarters probably underestimated the economic fallout. The slowdown in the developed countries was so significant that it basically led to a dramatic impact on imported goods and services.

Intrinsically, Asia appears to be in good shape. Its export sector has been significantly affected and that would largely explain the declines in GDP that we have seen. But even in the depth of the crisis late 2008, my conversations with various entities across Asia were not focussed on, "Oh my goodness, I am in negative equity, what am I going to do?". In fact, there was an underlying optimism. People would state that they were worried about what is going to happen, but at the same time would say, "this is a great buying opportunity".  

The key difference between Asia and the developed markets is that the Asian balancesheet, at the individual and corporate level, is relatively strong. And I think that this difference arises simply because post-Asian crisis, Asia de-leveraged significantly.
Now we see that in the recovery, though ‘recovery’ would be too strong a word to use right now, Asian equity markets, from the March lows, have outperformed. I feel the reason is that the fundamentals in Asia are quite strong and, therefore, Asia has the capacity to get out of it the fastest.

What led to this rally?

Markets declined very sharply late 2008 and early 2009. The final selloff which was very aggressive was more linked to a fear of a systematic collapse of the financial system. That has been averted. I frankly give central government authorities, globally, credit for this. They got criticised and drew plenty of flak, but these were extraordinary times and they had to think and act fast. And mostly because of their efforts, the world averted a financial disaster, which was not unthinkable at that time. Second, valuations were beaten to death.

Third, there was a lot of liquidity sitting on the sidelines. And with the realisation that the world was not going to end, this money began to flow into the market.

Global stimulus packages by governments also helped, both at the fiscal and monetary level. In Asia, China spent around $600 billion in two years. There was a strong element of re-stocking as against last year when there was major de-stocking going on. The numbers coming out also suggested that the worst was almost over.

So, it was more the lack of bad news that spurred the rally. The ‘green shoots’ of recovery were not sufficient.

Initially, that was definitely the case. There was a realisation that the world was not going to end and valuations had hit rock bottom. But there are numbers out there suggesting that there is some recovery taking place.

I don’t believe that there will be a ‘V-shaped’ recovery. There is still a lot of excess capacity out there. The U.S. may grow next year but not at 3-4 per cent. I feel it may be closer to 2-2.5 per cent. The export sector in Asia is likely to see some recovery but will mostly remain on the softer side. Asia will have to rely a lot on domestic demand. And that’s where countries like India and China stand out. But I still go back to the fact that the Asian individual has a lot of money. Balancesheets are strong. Asian corporates are strong. So, the ability to spend and invest is very much there.

China, being the largest user of copper, aluminium, iron ore and zinc, is key to many commodity prices. There are signs of credit tightening up in China and demand starting to come off. China’s July imports of copper shrank 15% from a month earlier. Would a slowdown in China’s commodity demand pose a risk to the price recovery of commodities?

Commodity prices have picked up. There was evidence that China was buying a lot of commodities. There was also evidence to indicate over- stocking in the short term. But then one looks at China on a medium term basis. It appears that they are going to keep spending money and are going to keep building roads and infrastructure. Going forward, they will need commodities.
China needs to keep GDP growth rates high. There is a lot of unemployment created in the export sector. A high unemployment problem could lead to social unrest. So, China has to stimulate domestic demand, hence the infrastructure push. I feel, in all likelihood, they can do it. The Chinese are relatively rich. They have $2 billion in foreign exchange reserves. This year, their budget will have a deficit of just 3 per cent.

What is the biggest risk to the India growth story?

I have been investing in the Indian equity market since 1991. I believe the only significant risk is that if the development of infrastructure does not increase at a feasible rate, a lot of bottlenecks will be created.

In 2008, China spent $400 billion on infrastructure, and I use this term in the broad sense of the word. India spent around $65-70 billion. This is just one single year; imagine the cumulative effect over the years. This development of infrastructure has majorly allowed for the spread of wealth across China. It has allowed industry to move further into the interiors of China. There is enough power, roads, communications to spread the wealth across the country. And for more balanced and sustainable growth going forward, that has to happen.

What holds India in good stead?

I believe it is the very strong private sector. The liberalisation and reforms unleashed the potential of the private sector. Indian corporates are very entrepreneurial, have good vision and management capability is quite strong. The growth of the private sector has been significant and this is likely to create wealth and further fuel strong domestic consumption.

If you look at Return 0n Equity, which is a good measure of efficiency, Indian corporates are around 16-17 per cent. This is probably one of the highest in the region. 

India also has world class companies. This will create growth going forward as India continues to open up to the world.  Other factors are a high savings rate and favourable demographics.

What is the main factor that you consider when buying a stock?

The main factor is management vision followed by the track record of the management. Have they been able to deliver on what they set out to do? If not, have they been able to articulate the reasons well? And whether or not their strategy makes sense. So, what I am saying is that management is key. Once you have the right management in place, other factors come into play.

So you believe that it’s crucial to meet company management?

Yes. It’s very important. It’s all very well looking at numbers, figuring out the cash flow analysis, etc., etc. But there is no substitute to eyeballing company management, seeing how they respond to questions and how they articulate their vision. It gives you a better feel and a higher degree of confidence to arrive at your decision.

What if the numbers are excellent, but the company refuses to meet you? Would you still invest in that company?

I would be saying something false if I stated that I have never invested in a company that I have never met. But, having said that, I would not be comfortable and the natural position would be to avoid an investment in that company. However, nothing is purely black and white. One also looks at the track record of the company, how it has delivered in the past, how transparent they have been about the statements they have been making, and then one builds a picture accordingly.

We also talk to the competition and those associated with the company — the suppliers, distributors and so on, to try to get an overall perspective.

Where do you see the market heading?

In the short term, say around 3 months, it is very difficult to make a prediction. We believe earnings growth in India over the next rolling 12 months may be a double digit figure. There is a concern over the monsoon, but it won’t severely hit corporate earnings growth, though selectively it could. With a double digit earnings growth, valuations are not stretched.

Fund managers in India are of the view that valuations are stretched and an earnings upgrade would be needed to justify them.
Everyone believes that India will have mostly double digit earnings growth next year. There is gradual recovery in global growth as well. So, globally, we can expect a better 2010. The export sector is likely to start picking up. It appears markets will start discounting for 2010 and 2011. I am confident that we will be in a better position a year down the road.