Booming Pacific/SE Asia funds turn cautious

Managers of funds investing in the Pacific and South East Asia delivered outstanding performance in the six months to the end of March 2007 but have now turned cautious on the outlook, seeing a variety of risks despite healthy fundamentals.

As detailed in Standard & Poor’s Fund Services, the leading provider of qualitative fund management ratings, latest sector update, available at funds.standardandpoors.com, the median South East Asia fund returned 19.4% in the six months to the end of March 2007, while the median Pacific mainstream fund returned 11.6%. This compared with 15.3% from funds investing in Europe including the UK and 7.3% from mainstream US funds.

Among the strongest performers in South East Asia was the S& P AAA-rated First State Investments – Asia Pacific Leaders Fund, with a return of 23.0%, mainly thanks to good stock selection in Malaysia, Australia and Singapore. Malaysian palm oil producer IOI Group, Australian transport and logistics provider Toll Holdings and Singapore utilities and marine group SembCorp Industries were particularly successful.

“The growth of this fund is also a reflection of the money investors have been pouring into the region,” said lead analyst Alison Cratchley, explaining that originally launched to take the pressure off sister fund First State Asia Pacific Fund, Asia Pacific Leaders Fund is now larger, at £1bn against £830m.

After their strong six-month run, most of the Pacific and South East Asia fund managers are cautious on the outlook, although they agree that the macroeconomic and corporate fundamentals remain healthy. They take differing views of the US economy and its impact on their region. Millicent Lai, manager of the S& P A-rated Schroder Pacific Fund identifies two risks: a sharp slowdown in the US economy caused by a collapse in the housing market or, alternatively, a rise in interest rates caused by cost push pressures. She notes that valuations are near the top end of their historic range, leaving the markets vulnerable to earnings disappointments.

In contrast, Vanessa Donegan at the S& P AA-rated Threadneedle Investment Funds – Asia Fund does not expect a severe US slowdown and believes that the Asian economies will weather a moderate economic slowdown reasonably well. However she worries that an upset to the benign liquidity conditions globally would lead to a deterioration in the appetite for higher risk assets and so to a de-rating of Asian stocks.

A noticeable theme across all funds in the region is increasing domestic consumption. The S& P A-rated JP Morgan Funds – JPM Pacific Equity Fund is typical of many with an emphasis on consumption-related stocks such as financial and property companies.

Another popular theme is increasing capital spending and infrastructure investment.

Most funds are currently underweight in cyclical sectors, with materials and technology sectors particularly underweight. Donegan at Threadneedle has reduced the technology weighting of her fund to its lowest ever level of 12% on concern about the sector’s lack of pricing power.