Look East Before It's Too Late

Published in Investing on 21 November 2012

David Kuo chats with Hugh Young, managing director of Aberdeen Asset Management Asia.

The Motley Fool's David Kuo chats with Hugh Young, managing director of Aberdeen Asset Management Asia. Hugh, who is one of the emerging market's most successful fund managers, explains why investors should diversify their sources of income away from traditional UK equity. He also explains the rationale behind his hefty exposure to the financial sector that include Standard Chartered (LSE: STAN), Overseas Chinese Banking Corporation, United Overseas Bank and DBS.

Listen out for this week's competition for your chance to win a copy of Hugh's book, Ten Golden Rules of Equity Investing. To enter the competition, email your answer to moneytalk@fool.co.uk. The closing date is Sunday 2 December 2012. Read the full terms & conditions for this competition.

You can listen to or download the full podcast here.

David:

This is Money Talk, the weekly investing podcast from The Motley Fool. I am David Kuo, and today I am back home in Singapore. Yes, you heard me right – I am 85 miles from the equator, in the country also known as the Lion City. But I'm not here to soak up the sun, but instead I'm here to soak up the investing knowledge of one of the most successful emerging market investors. I am in the offices of the managing director of Aberdeen Asset Management Asia, which is only a stone's throw away from Raffles Place. Yes, I am with Hugh Young, who has had more than 20 years' investing experience in the developing markets. So, without further ado, thank you for chatting to me today, Hugh.

Hugh:

Thank you, David.

David:

These are amazing offices I'm in.

Hugh:

I hope you like them, they're a bit different, aren't they? They're not the normal high rise that you get.

David:

No, it's got this sort of very unique feel about Singapore, yes, so they were a good choice. Now, the first question I want to ask you, Hugh, is: how different is it to invest in companies in the east, compared to investing in companies in the west?

Hugh:

I think investing in companies is the same wherever you go, so the fundamentals behind it are exactly the same, whether you're investing out of London, or here into Asia, so you've got to look for decent businesses, run by honourable people, with clear and transparent accounting. So those basic issues are universals, I would argue. Does Asia have different characteristics? – yes, it does, so certainly, when you look at, underneath the bonnet a bit, you find companies that are typically, there'll be more companies run by families, so more family ownership. The ownership of companies has not become as diversified as, say, for example, ownership of companies in the UK, or the US, so that is an extra wrinkle. Government intervention also can be very heavy in parts of Asia, so most of China is owned by the government, which is again very different from your Nestlés,  your Procter & Gambles (NYSE: PG.US), your IBMs (NYSE: IBM.US).

David:

So looking at specific companies in Singapore, how do you feel about sovereign wealth funds having huge amounts of investments in Singapore-listed companies?

Hugh:

Well, sovereign wealth funds these days have huge investments in various companies worldwide. If you look at Singapore itself as a marketplace, much of Singapore was really started by one of Singapore's sovereign wealth funds, effectively Temasek, which is an arm of the government, which always makes one think twice, of course – is this being run for minority shareholders, or is it being run for the good of the country? I think, in Singapore's case, we've seen a clear evolution of the way the government intervenes, or gets involved in marketplaces, so Temasek, while still quite an active investor, has withdrawn substantially from very active investment in the local market, to more of a traditional investor, encouraging actually some of the best corporate governance practices we see across the region. So it's become a lot more mature market, the development functions, so that the Singapore market that the sovereign wealth fund had in the early days, is by and large redundant.

David:

So do you think it's actually a good thing to have a huge government interest in companies that you are invested in yourself?

Hugh:

No, I think you've got to be very careful. I think it's a broad brush, and looking beyond Singapore, I think you've got to be very careful how the government acts within the markets. Looking at China, for example, where the Chinese government is far more interventionist, and is using the companies in which it invests, whether it be the ministry or the central government, it's using the companies in which it invests as arms of government policy, then you've got to be far more careful. I think where Singapore has, for example, developed an industry that can stand on its own two feet, whether it's the airline, the bank or whatever, there's a lot more competition, and for us, the government-linked companies, as they're still called in Singapore, would come into the category of some of the better-run companies, within the region as a whole, and certainly run fairly independently of sovereign wealth funds, so it's gone to that more mature stage.

David:

OK, now you once said that, over the longer term, the Asian-Pacific region would continue to offer investors the opportunity to diversify their sources of income, from traditional UK equities, such as fixed income and the property sector. So how important do you think it is for foreign investors, particularly western investors, to look to the east for income?

Hugh:

Well, I think, as far as income generation is concerned, if you're looking specifically eastwards for income, can you get that in a variety of means? – yes, you can. That can either be in the traditional fixed income markets of Asia, and Asia has developing bond markets, but more particularly, if one's looking at equities, of course, where you're seeing growing earnings, typically with growing earnings comes growing dividends underneath, and that's certainly what we've witnessed here in Asia. Is it exclusive to Asia? – no, because I think, when you phrased the earlier question, I think one's still got to be careful. You can find, listed in the UK, many companies that derive a big chunk of their profits from Asia, or emerging markets. So I think the simple divisions by country of listing, and assuming that, wherever a company is listed, defines where its earnings come from, has become far more of a blur these days than ever it was twenty or thirty years ago. So companies have internationalised, we've got Singaporean companies with chunky earnings out of the west, and vice-versa, western companies with chunky earnings coming out of Asia. So if you do your homework, you can find companies benefiting from the growth of Asia, which is still pretty self-evident, irrespective of where those companies are listed.

David:

OK, now then, I was looking at one specific fund, was the Aberdeen Asia-Pacific Fund, and it has almost 30% of its investments in financials. We know what the financial sector has done in the west – does this worry you, at all? Thirty-eight% of the fund is in financials.

Hugh:

Yeah, it certainly worried quite a few of our investors during the, well what certain people call the global financial crisis of recent years, what we call the western financial crisis, of recent years, and people said, my God – you're holding all these financials; aren't they all bust? – and the answer here was, no actually, they're very very different beasts, and certainly if you split up the financial sector, and very crudely, say 40% in financials, half of that, 20%, is in banks. Then, if you look at how the Asian banks have run their businesses, and how they've been regulated, they're very very different beasts from the banks that blew up in the west. So typically, their loan/deposit ratios are comfortably below 100%; their funding comes from deposits, not the wholesale side; they didn't get into all these exotic proprietary trading vehicles that the western banks got into; their lending is well-regulated, again by strong regulators. So for us, they've actually been very straightforward plays on growing consumer wealth. So as people grow wealthier in Asia, they open a bank account to start with. They take out a credit card, they take out a mortgage; heaven forbid, they even buy unit trust products through a bank, so it's a very very plain vanilla approach, compared to what the city banks and the Scottish banks did.

David:

OK, so looking at two specific banks, we have OCBC, Overseas Chinese Banking Corporation, and also UOB, United Overseas Bank. Why do you prefer these two banks over the Development Bank of Singapore, the DBS?

Hugh:

Yes, in our regional funds, these are two big Singapore bank holdings. I should say that we do own DBS as well, in our Singapore dedicated fund, which is another fund that we have, although DBS has been a comparatively recent addition to our portfolios – it only started a couple of years ago. The reason we preferred OCBC, as we call it, and the UOB, over DBS, were fairly straightforward. DBS has been through a lot of management change, so in the short twenty years I've been here in Singapore, we've seen various changes at the top, an organisation that has not been particularly stable from the management point of view, although the underlying business is a very strong one. So we felt far more comfortable with essentially the family-owned companies, OCBC and UOB. Again, similar characteristics across all three banks; very conservative; very strong, sensible regulator; very high capital adequacy rates, and very solid portfolios. So we like all three, is the honest answer, today, but for historical reasons, we did avoid DBS because of management changes, in favour of OCBC and UOB, and now all three are being equally well-run.

David:

OK, so what about Standard Chartered, then? How do you feel about Standard Chartered being embroiled in some of the problems that has happened in the west?

Hugh:

I suppose it's inevitable, if you are a western bank, you can't avoid things. Certainly, we've been holders of Standard Chartered in our Asian funds, as well as our UK funds, for something like seven years. Standard Chartered has been very much an Asian bank, so if you look at the buildings round the corner here, you'll see the vast majority of Standard Chartered central staff are actually based in Singapore, and the largest shareholder is based in Singapore, and it's built out a fantastically strong Asian franchise, and has done exceptionally well over the years. Certainly when the recent scandal erupted in New York, I think we were as shocked as any by what went on. We understood that Standard Chartered, along with lots of other banks, have been investigated for what's happening with the US dollars, and how US dollars have been processed through New York, but the 27 or 28-page statement that came out of Mr Lawsky from New York, was quite shocking stuff. Certainly the language within it reminded me of Law and Order on TV, it was really attacking language, and we didn't recognise, in that language, the bank that we knew well, so we know it well at all sorts of levels. We have staff members whose spouses worked there, and Standard Chartered is quite a compliant organisation, so we were surprised at the virulence of the attack, and not pleased, obviously – nobody can be pleased; worried. Within our portfolios, we actually took the opportunity to add a little to Standard Chartered, on that weakness.

David:

Add, rather than to take away?

Hugh:

Yes, because we didn't think that Standard Chartered was a rogue bank, so the statements within the accusations, that Standard Chartered was a rogue bank, we simply did not recognise Standard Chartered as being a rogue bank.

David:

I think that's the kind of feelings that some of our analysts at The Motley Fool in the UK also felt, when they looked at it. They thought, this can't be right, or if it is right, it's not totally right, it was coming out from America, yeah.

Hugh:

Yes, exactly. Was it within the letter of the law? – well, obviously if they paid a huge fine to settle things, and it wasn't within the letter of the law.

David:

OK, let's move onto another company, and this is Jardine Strategic Holding. You have quite a big position in Jardines. Why do you think conglomerates are so popular here in the east, whereas in the west, they seem to have been dismantled in some respects. I'm thinking here about Trafalgar House, I'm thinking about Lonrho (LSE: LONR), where there was a conglomerate. So why do you think conglomerates are popular here, but less so in the west?

Hugh:

Well, I'm not sure they are popular here necessarily, so conglomerates often do trade at discounts, so there is a conglomerate discount often that applies in markets, and I think people can be very suspicious, in the east, of conglomerates as well. Are there still quite a few conglomerates here? – yes, they are; and why is that? – because they're family-controlled, and the majority, and Jardines is not strictly family-controlled, but effectively, if you look at the cross holdings between Jardine Strategic and Jardine Matheson ...

David:

And the rest, the Jardine Cycle and Carriage, and Hong Kong Land and Dairy Farm – it does become very convoluted.

Hugh:

Yes, although the key cross holding is at the Matheson and Strategic level, so in that sense, effectively it is the same as many other conglomerates in Asia that will just have a simple unitary structure at the holding company level, but 55%, for the sake of argument, family ownership. I guess you could look at Swires, if you call that a conglomerate, which we're also shareholders of, by the way. I think you've got to be careful with conglomerates. Again, as with other listed companies, you've got to make sure that the people behind them are straight, and that they're well-run. There are added complications to conglomerates, insofar as there are more moving parts, by definition, so it's harder to analyse. The fans of conglomerates, and often the people who run the conglomerates themselves, will say that it smoothes out businesses if they have one cyclical business on one side, and another stable business here, and they don't all have bad years together.

David:

It's a bit like the ice-cream sellers that sells umbrellas at the same time, yeah? – so you actually sort of get a bit of both. Let's have a look at your Indian exposure. You have a huge chunk of change in India, but this is through Aberdeen Global Indian Equity. Is this the only way that you can invest in India?

Hugh:

No, we invest in India, depending on clients, either through our own India funds. Sometimes we invest everything via our own India fund. Now, the rationale behind that is that our India fund is structured through Mauritius, so with the double tax treaty in Mauritius, you're not hit with the capital gains tax that India would levy. For our unit trusts, we're only allowed a maximum of 5% in that vehicle, so another unit trust can only hold up to 5% of a unit trust, and then we also supplement it by direct investments in India. Overall in India, very roughly we have about 12%, which, as you say, is a chunk of change, although when I think, to the man in the street, 12% in India, looking at Asia, doesn't seem that much; I mean, India's the second biggest country in Asia – 12% isn't that bad. 12% in India compared to say 20% in Scots listed in Singapore, which is five million people, not untoward. India has some fantastic companies. It really has grown certain industries phenomenally well. The IT services' industry is probably the best-recognised industry that India's done well at, whether it's the likes of Infosys (NASDAQ: INFY.US), or Tata (NYSE: TCL.US) and Wipro (NYSE: WIT.US), and the like, have been wonderful; some of the pharmaceutical companies; some of the home-grown financials. I only wish I could, hand on heart, say they're all as cheap as chips. I mean, it's not a cheap market.

David:

No, it's not. Now, the other thing is, you also have a huge investment in mining companies, through Rio Tinto (LSE: RIO) and BHP Billiton (LSE: BLT), and of course I am in the country which is now home to Jim Rogers, and Jim Rogers talks an awful lot about the supercycle. So by investing in mining companies, are you buying into the supercycle idea?

Hugh:

That's not why we invest in them, but I guess you could argue that, if you wanted to put on a bull case. We've invested in Rios primarily for the longest time, over twenty years, so I've been looking after our portfolios now since 1985, and we've had a holding in Rios for well over twenty years, not because of any great foresight that China would boom, and iron ore prices would hit the roof, but simply because Rio sat on a huge amount of assets in the ground that would last for decades, in relatively safe countries. That was the rationale, and over time there would be a requirement for those assets, and Rios was a very well-run company, and now BHP is equally well-run, I think, from a day-to-day management point of view. Twenty years ago, it was a bit of a political toy amongst various of the Australian tycoons, but both BHP and Rio are now top of the class as to what they represent, and at the same time they have developed, so they've metamorphosed into effectively a play on the growth of China, and as such, we feel rather more comfortable with them than we do with many of the companies in China itself, which we don't know as well, and which are not necessarily runners, as professionally for end shareholders such as us.

David:

And talking about China, what are your views about the country? – do you think it is going to make a soft landing or a hard landing? – or have we landed already, and we're actually on the way back up again? What is going on in China?

Hugh:

Well, I wish we had the definitive answer to this, and China, as we've seen from various headlines over the last year, has surprised even the closest of the China watchers, the Bo XiLai. On balance, we think China will have a soft landing, and that China does have the wherewithal to ensure that the landing is soft. Does that mean we think Chinese companies are great things to invest in? – no, it doesn't, and even when China was soaring away, and didn't have the issues five or more years ago, and we also run dedicated China funds, we've been very leery of putting money direct into Chinese companies because, coming back to how the market is constituted, the bulk of the companies listed in China are arms of the government, and when a country's still at quite a developmental stage, we're a little less comfortable, being a minority shareholder in such companies. Then there's a raft of new listed companies that have come to market, where we don't know the history of them, and we haven't seen the history of how they act in the public markets, and we've tended to steer clear. We're quite conservative about how we approach investing clients' money. As you will have seen from the headlines, there have been a whole raft of scandals amongst the smaller listed Chinese companies, whether they're listed in Hong Kong, Singapore, or indeed New York.

David:

There is one Singapore company that is a Chinese company listed in Singapore. I think they were supposed to be making food products, and the managing director, I think, took some of the money to invest in the movie industry in China, so these are really quite difficult areas for the private investor to go into.

Hugh:

Yes, I think it's especially difficult, and we're especially sceptical of companies that list outside their own home jurisdiction, because often if something does go wrong, it's not just true of China companies, although there have been a fair few of them, I'm afraid; if something does go wrong, you've got no access to the management or the assets, or whatever. So we've had scandals in Singapore, with China companies; we've had scandals in New York, and scandals in Hong Kong too.

David:

OK, my final question, Hugh, is something that touches on several areas, and it concerns your investment in a company called City Developments, which is a property company here in Singapore. Now, there are some commentators, both here and also in the west, that are saying that the printing of fresh money in America, Europe and the UK, otherwise known as quantitative easing, this is ending up as hot money in Singapore, and is pushing up property prices. So, how is that likely to affect real estate investment trusts in Singapore, not specifically to City Developments, but just to property prices in the Republic?

Hugh:

You're absolutely right – this is one of the unintended consequences of the dreaded QE that we've seen, and it has been driving asset prices up in other parts of the world. Now, that can be equity markets as well, which have done surprisingly well, considering the global economic backdrop, or indeed property prices, and Singapore has had to face soaring property prices, and a strong currency. So what Singapore has done has been to take various measures against that, so that the government is quite interventionist in that sense, so has put restrictions on mortgages, restrictions on second ownerships – all sorts of restrictions to try and cool down the property market, which has succeeded, and that's hit short term, that's hit some of the listed companies, but frankly, they've done so well over the last five years, with the rise in property prices, that I think it's a relatively short term bullet. But it's causing government intervention across the region, and it is concerning governments. Property is a very visible aspect of the flow of money, the printing of money in the west, coming to this part of the world. You're seeing it in the currency markets. You're seeing it in any stocks with a yield on, so people are flying into yield stocks, and you've got to be very careful, yes, and yield is a good thing to have, but you've got to be very careful how that yield is manufactured, and if it's artificially manufactured, at the end of the day, something nasty is going to happen.

David:

But bizarrely, it's also hurting Hong Kong, because the Hong Kong dollar is pegged to the US dollar, and people are flooding into the Hong Kong dollar, for what reason I have no idea, but it's pushing the Hong Kong dollar up to the top level of the peg, so much so that the Hong Kong monetary authority is having to sell Hong Kong dollars, in order to bring it back down, and yet the Singapore government is quite happy, in some regards, to allow the Singapore dollar to appreciate.

Hugh:

Yes, the two have adopted quite similar policies in specific areas, so similar policies on property, trying to make it essentially more difficult to borrow when they invest in property, and particularly if you're foreign. But they've both adopted very different policies as far as the currency is concerned, so Hong Kong is still wedded to the peg of Singapore. You've seen the Singapore dollar appreciate very strongly, and it's made Singapore an expensive place to live. So no longer is it the cheap and cheerful place it was when I first moved here twenty years ago – it's rather horrifying to anyone coming here from the outside these days.

David:

It is frighteningly expensive. Well, thank you so much for talking to me today, Hugh. I just have a couple of chores to perform. The first one, and you may not know this, but it is to give away copies of your book, Hugh Young's Ten Golden Rules of Equity Investing. I read the book – it is very Foolish, in the sense that it is everything that The Motley Fool embrace – it's those ten rules that we have ourselves about investing. So I'd like to give away some copies of your book, and in order to win a copy of your book, copies of your book, you need to answer this very simple quiz question, and the question is (now, listen up): what is the name of Singapore's international airport? If you can tell me what the name of Singapore's international airport is, you will get a copy of this book. You know the answer, don't you, Hugh?

Hugh:

I know the answer. I'm not allowed to tell though, am I?

David:

You're not allowed to tell us that, no – OK. My other chore is to find a quote to sum up today's podcast, and today's quote comes from a lady called Mary Engelbreit, who said: “If you don't like something, change it. If you can't change it, change the way you think about it.” I think this is for people who are investing outside of the emerging markets – think very seriously about the emerging markets. Don't just stick in your home market, and invest in either American shares or UK shares or European shares, but think about emerging market shares, because it's not as frightening as people make it out to be, is it?

Hugh:

No, it's not, and you might already be investing in them in your own home market, and not know it.

David:

Yeah, quite right, OK. So thank you once again, Hugh. I have been David Kuo, and my guest has been Hugh Young, Managing Director from Aberdeen Asset Management Asia. If you have a comment about today's show, you can post it on the Money Talk web page, which you can find at fool.co.uk/podcast, and if you want to follow my adventures in Asia, you can follow me on Twitter @TheKuoKnows. Until next time, Terima Kasih.

David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors Of 2012" -- while it's still free!

> The Motley Fool owns shares in Standard Chartered.

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Comments

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XMFSonia 21 Nov 2012 , 11:05am

Hey Fools

Don't forget to supply your postal address when entering this competition.

Thanks!
Sonia

XMFSonia 26 Nov 2012 , 3:15pm

Hi Fools

Thank you to everyone who entered the competition.

The answer to the podcast question is Singapore Changi Airport, and the 10 lucky winners are...

Jan from Kent
Dave from Pontefract
Ben from Barnet
Chris from Hull
Pete from Wrexham
Jimmy from Halifax
Steven from Derby
Adam from Swansea
Richard from Boxford
Michael from London

A copy of Hugh Young’s Ten Golden Rules of Equity Investing is on its way to you in the post.

Congratulations!
Sonia

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