Join our community of smart investors

Asian growth story 'cheapest for a decade'

FUNDS INTERVIEW: Moira O'Neill talks to Mike Kerley about his high exposure to Asian income and the attractions of the region's banks
May 19, 2009

"As a region, Asia is no stranger to coping with financial crises, except this time it is not one of their own making. Does this make Asian equities look cheap? If you can buy a structural growth story for the next 20 years at valuations you see only once every decade, then it's a good opportunity." So says Mike Kerley, fund manager of Henderson Far East Income, the first investment trust to specialise in Asian income - starting back in 1989.

He points out that valuations in Asia are back to levels not seen since the Asian crisis in 1997 even though the recent financial crisis has not been created in Asia. Hong Kong property, for example, has more than halved in some cases, and stocks such as Sino Land offer good potential value.

So where is he investing for income in Asia? Three key themes account for over 70 per cent of the portfolio.

First and foremost: financials. He has a high exposure to Asian financials, especially bank stock such as DBS (Development Bank of Singapore) and Bank of China.

He argues that most Asian banks are the polar opposite to banks in the west carrying excess liquidity, and unlikely to suffer the higher provisioning of their developed peers yet have been sold down to levels which do not coincide with their superior fundamentals. In fact, financials are trading at levels below where they were in the Asian crisis.

"Consider the banks in the US and the UK," says Mr Kerley. "They lend out far more than their deposit base and rely on credit markets to fund this, which has been shown to be ill-advised, costly and ultimately catastrophic."

Although the Australian market is closely aligned with the UK banking model, elsewhere in Asia, the deposit base more than covers the lending, so there are no serious liquidity issues. "Banks are the opportunity in Asia. Asian loans to deposit ratios are 80 per cent," he says. "Asian banks do what banks should do and make money on margins. People aren't overleveraged in Asia so there is not the risk of people giving up on mortgages and credit cards."

But the "huge opportunity" for Asian banks is to step in with attractive competitive rates while global banks, such as HSBC and Goldman Sachs, "aren't interested in Asia as they have too many problems at home".

Mr Kerley admits there are exceptions, namely financials in Australia, Korea and India. The Henderson Far East Income portfolio has very little exposure to these.

His second big theme is infrastructure spending: "The key catalyst for growth is what governments will spend. We've seen big numbers coming out of China and Korea." China, for example, is to spend 7 per cent of GDP on infrastructure in each of the next two years.

Third, and most important for income, is telecommunications: "The real high yielding stuff in Asia is in the telecoms sector," he says. "Demand for telecoms is not very cyclical in nature - demand for fixed line phones and broadband does not change in economic cycles."

An unusual holding under the telecommunications theme is Philippine Long Distance Telecom. "It has a 60 per cent market share in mobiles. The Philippines has more texting per head than in Europe - 80 per cent of the company's revenue is from text."

Overall, Mr Kerley's focus is firmly on domestic Asia and away from exporters or cyclicals. He says: "The key thing for the next 20 years in Asia is to change the focus of growth. Up to now growth has been in the export sector. The problem with that has been it makes stocks in the economies very cyclical. We have seen negative GDPs in Asia because of the export sector.

"When exports drop you get massive drop in GDP growth. Therefore governments have brought in policies to stimulate consumption.

"Asian countries have been saving and need to start spending. Consumption as a percentage of GDP is very low. That's where the focus in Asia will be in the next 10 years."

As for the growing dividend culture in Asia, Mr Kerley believes dividend growth will outstrip earnings growth over the next two years. Domestic companies carry little gearing and currently have low payout ratios and while their earnings may slow, these companies are well able to maintain or even grow their dividend. "The corporate sector is strong. Gearing in Asia is lower than anywhere else in the world. More companies are doing share buybacks and corporate dividends," he says.

"Are dividends sustainable? I think they are. Dividends may come down this year but there are factors in Asia that make it more sustainable."

Mike Kerley CV:
Mike Kerley joined Henderson in 2004 to manage Pacific equities and has managed Henderson Far East Income since 2007. Michael has 15 years' investment experience in the Asian market, previously with Invesco Asset Management where he developed a value driven investment style.

He thinks the real country of opportunity in Asia is China, which is expected to be the driver of global growth over the next 10-20 years. The country has in recent years been hugely overpriced but has in recent months fallen more than 50 per cent from its highs and trades at a discount to the region. GDP growth is expected to be more than 7 per cent in 2009, owing to the strength of consumption and investment - offsetting exports. "At the moment Chinese valuations are roughly in line with the rest of the world," he says.

He has recently increased exposure to the long term growth story of China following the significant falls in share price. "Stocks in this country typically carry a lower yield relative to the region but have solid fundamentals and a strong chance of growing dividends over time," he says.

Over the last three years, net exports have contributed significantly to China's double digit GDP growth but Mr Kerley says this contribution could turn negative in 20009 and 2010. However, the Chinese authorities are aware of this and have embarked on a substantial domestic program of expenditure to offset the impact of slowing global trade.

"The easy money has been made globally," he says. "The question is where are we in this economic cycle and what should we pay? I think we're at fair value. But investors should be looking at Asia for the long term.

"The Chinese won't be paying for their fiscal deficit as long as our children will be."