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You would think that with some stock markets in Asia up by more than 100 percent in the past year, mutual fund managers who invest there would look like geniuses.
Wrong--as I discovered when I screened for mutual funds that invest in Asia, exclusive of Japan.
My challenge was to find funds of more than $50 million that rose by 40 percent or more this year and were down no more than 6 percent over three years--reaching back well before the onset of the economic crisis--and have reasonable expenses.
The list I came up with is very short. And even within this small group of high achievers, you still have to be ready for far more volatility than you may be accustomed to when investing at home.
The worst of the Asian crisis appears to be over, but being aware that huge downward swings are still possible in Asian markets is crucial. Look no further than this year's star market, South Korea. The country is supposedly on the road to reform, but the market can plunge by 7 percent in a day when one of the biggest business groups in the country totters on the brink of bankruptcy, threatening banks with its huge loans still outstanding.
Elsewhere, Asia's largest market outside Japan--Hong Kong--is already back to pre-crisis levels, even though the real economy is still sunk deep in recession.
Not that investing a portion of your wealth in the world's most populous region is a bad idea over the long term. In the end, investors in competitive companies that are well-run, with adequate crisis planning and manageable debts, will be able to ride out any storm that comes. But be prepared for a bumpy ride.
Most of the best funds buying Asian stocks outside Japan fell by at least 60 percent from pre-crisis highs to crisis lows, and even a good fund such as the Putnam Asia Pacific, which also invests in less-volatile Japan, fell 43 percent from top to bottom.
What else could prompt another sharp fall? An interruption in the pace of regulatory reform and bank recapitalizations might. Or a big slowdown in the U.S. economy, if world investors get scared off by America's record current account deficit and dump their stocks and bonds. America buys a lot of Asia's exports and has helped fuel the region's recovery.
As I wrote last month, I would hesitate to invest in a single-country fund, which places all my bets with one set of government reformers and central bankers. For Asia, I want a stock picker, since stock pickers have routinely beaten the regional index in Asia before, during and after the crisis.
Of the funds that have come back strongly this year and have good longer-term records, I was pleased to find the Matthews Pacific Tiger Fund (symbol MAPTX, 1-800-789-2742), which I like because its managers resist the temptation to spread their bets around according to index country weightings. Since its inception in 1994, the fund has steadily outperformed the Morgan Stanley All Countries Far East Free Index (exclusive of Japan). "We as managers don't believe indexes are a proper way to structure our lives," said Matthews fund co-manager Mark Headley. "We're trying to create what we think will be the index five years from now."
Headley is heavily invested in South Korea, a country he calls a first-world economy with a Third World financial system. And although he figures reform there risks stalling because the soaring stock market is dampening the impetus to sell off insolvent banks and reduce the towering debt levels of the top conglomerates, he said he is nonetheless confident that reform will continue.
"If they really bite the bullet the place will look fabulous in three years. The political reality is five years," he said.
On the other hand, Headley said, "Thailand is basically a Third World country with the veneer of a first-world financial structure." As if on cue, a few days later Thai authorities said that 15 percent to 20 percent of the bad loans in the country's banking system that had been restructured had again gone bad.
Another reason I like the Matthews fund is that unlike a lot of Asian funds, it does not have huge holdings in Hong Kong. The Hong Kong market is way up this year as waves of foreign money have sloshed into Asia, but reform in Hong Kong has been slow in coming. It has a fixed currency, but has propped up real estate prices and has therefore priced itself way above competitor Singapore in the race to attract regional commercial headquarters.
Another decent fund with reasonable fees, the T. Rowe Price New Asia Fund (PRASX, 1-800-231-8432) takes the same dim view of slavishly adhering to an index, and goes so far as to put money into India, which is not part of the index most funds in this category are measured against. "Indices tend to lag what the opportunity is," said manager Mark Edwards.
"We think the future is good-quality technology companies with higher returns on equity," he said. As such, he cannot ignore India, partly because of a wealth of software companies around the city of Bangalore.
The future for Asia contrasts with what in my opinion he rightly identifies as the "old Asia before the economic crisis: profitless growth," in which companies just kept borrowing more and more money to sink into unprofitable real estate, golf courses, or heavy industry that couldn't be justified by demand.
Even though Korea was one of the worst abusers of the model of profitless growth, the New Asia Fund, like the Matthews fund, is bullish on some Korean companies, such as super-efficient Samsung Electronics, a semiconductor maker. Still, as a reminder of how far Korea has to go--and the perils of investing in a Korea country fund--the highly indebted Daewoo Group at the end of July came perilously close to going bankrupt until creditors forked over another $3.3 billion to keep it alive.
Another way to invest in Asia is to pick a fund that includes Japan as well. Just as the world's second-largest economy faltered in 1990 when the world seemed convinced it had thoroughly beaten America's economic model into the ground, it may be time for Japan and its many fine companies to make a comeback despite the widespread faith in America's "new economy."
A strengthening yen, as we have seen this year, may hurt Japanese exports, but it helps dollar-based investors in Japan, and Merrill Lynch strategist Trevor Greetham points out that only 10 percent of Japan's economy gets exported to other countries.
Fidelity's Pacific Basin Fund (FPBFX, 1-800-544-6666) is a solid fund investing across Asia, although it carries a 3 percent front-end load. Another good choice is Putnam's Asia Pacific Growth Fund (PAPAX and PAPBX, phone 1-800-225-1581).
Putnam manager Paul Warren is currently under-invested in Japan. As in Korea, the question in Japan is whether the beginnings of reform that are underway will actually stick. Since the jury is still out, it is smaller-company funds that have led the way in Japan in the past three years, because they shy away from the overleveraged corporate Godzillas that are the Japanese household names in America.
Yet Warren identified a few large Japanese companies that in his view are becoming more efficient, including Sony, Matsushita, Toshiba and Fujitsu. Toshiba had a return on assets last year of 1 percent, compared with 20 percent for General Electric, but then it fired its CEO. In his place is the former head of Toshiba's U.S. subsidiary, who has now guided Toshiba into joint ventures with United Technologies and GE's power business. The goal is a tenfold increase in return on assets.
Ironically, Warren said, "Toshiba's catalyst is a weak balance sheet. In many respects, the weaker the balance sheet the more pressure they have to restructure." A case, it seems, in which less may actually be more.
Philip Segal is the Hong Kong correspondent of the International Herald Tribune.
CAPTION: CONSIDERING ASIA FUNDS (This graphic was not available)