Regional investing in a global financial crisis

Cherry-picking regional economies for investment opportunities make good sense when the world economy is in crisis.

The global financial crisis (GFC) makes the case even more compelling for investing regionally because it encourages investors to look beyond Europe and the United States to find durable economies not riddled with financial woes. And experts say it is becoming easier for investors to see those regional investment opportunities.

"The dust is settling from the global financial crisis and markets are behaving more rationally," AMP chief economist Shane Oliver says. "Now is the time to look at markets that have been penalised by this crisis."

Investors' outlook has been clouded by factors such as the international liquidity crisis and investor uncertainty, he says. "But when you get a bit more stability and less uncertainty, investors become more discerning about where they would like to invest. And this is starting to happen now," Oliver adds.

"China and India are looking pretty good value. They are falling back to being quite cheap and there's a growth story which is pretty attractive."

Aberdeen Asset Management senior investment specialist Stuart James agrees: "More and more people are concerned that we are seeing the US in a different place in the medium term and we're seeing stronger fundamentals elsewhere."

The central element to regional investing requires the assessment of a country and the companies within it on their own merits, resisting the temptation to believe that the GFC has ravaged all countries in the same way creating the same recovery prospects.

Outlook for recovery
The International Monetary Fund's March 13-14, 2009 report, titled 'Global Economic Policies and Prospects,' evaluated the recovery prospects of regions around the world and noted their differing reactions to the GFC and paths to recovery.

"Advanced economies will suffer deep recession in 2009, specifically G7 economies," the report says. "With negative momentum and the limited effect of policy actions to lift uncertainty or address financial strains to date, the adverse macro financial loops have intensified and prospects for recovery before mid-2010 are receding."

Meanwhile, in emerging and developing economies, activity is expected to expand weakly in 2009 before recovering gradually in 2010, according to the report.

The IMF ranked Central and Eastern Europe and the Commonwealth of Independent States to be the worst affected because of their large current account deficits, but said emerging Asia was also being hurt by its reliance on manufacturing exports. Latin America's tight fiscal conditions and weaker external demands were regarded as a drag on growth.

According to James, the world can currently be split into two groups--the creditor nations and emerging markets and the debtor nations which include Europe, the US and Australia.

While the debtor nations will take 4-5 years to deleverage, companies and governments in the creditor nations have positive balance sheets, he says. "The fundamentals of their financial situation are stronger than in the debtor nations," James says.

This is also the argument of India Equities Fund Limited's chief executive officer John Pereira. India's gross domestic product has not been affected as greatly by the GFC as has been the case in western nations, and the reasons behind this fact make it an attractive regional investment, Pereira says.

India has a very domestically driven economy, with the median age of its population under 25 years. Apart from its young and highly aspirational population, it also has a formative and growing middle class, sized somewhere between 200 million people and 350 million people.

"So you have a very large population and the population will need to be serviced by everything, you can't leave anything out," Pereira says. He adds: "There are other places in the world to invest but they still don't have democracies and experienced regulators."

Growth hot spots
James says China is poised to have the strongest growth at 6% next year, so "it's at the front of the pack" in terms of regional growth opportunities. That said, he says a lot of Chinese companies are geared for exporting and business loans increased by 20% in the first two months of this year.

"The companies that need this money are not performing companies," James says. "As much as it is painful, a lot of these companies should go bankrupt. Everyone is being propped up and economic forces are not being left to run their natural force." Further, the IMF says growth in China is also slowing.

Russia is also considered a relatively good growth opportunity. Its economy posted 1.1% GDP growth in the fourth quarter of last year and so is not in recession, plus it is also a large exporter of petrol and chemicals.

"But its corporate governance disappoints," James says. "Too much politics."

With only 23% of its GDP coming from exports, India is definitely regarded as possessing good investment opportunities. "It is one of the most domestically driven economies with excellent companies to invest in," says James. "They're very entrepreneurial but there is a lot of red tape."

Pereira disagrees that India is bureaucratically difficult: "Since 1991 when there was deregulation in India there have been four prime ministers, but the agenda for financial change hasn't changed. India is a democracy and has a very good regulated economic system."

Challenges to investing regionally
One of the most difficult challenges for investors is gaining adequate diversification with their regional exposure. Oliver says this is because indices such as the MSCI World are geared towards high income countries with low growth opportunities such as the US, Europe and Japan.

"So even if you want 10-20%, you end up with a low growth exposure to countries such as China and India," Oliver says. He adds: "The MSCI is nice and easy but it is not the way to generate good returns over the next few years."

Pereira says lack of exposure to countries such as India is not doing investors any favours. "My argument is we should be looking for large countries like India to make sure we're diversified."

Should investors avoid countries in recession?
James says regional investment opportunities cannot be judged over whether a country is in recession or not because there are other important factors that come into play. For example, the global banking crisis is affecting the attractiveness of bank stocks because there is a problem with funding. "So I wouldn't invest in banks," James says.

But of course the state of a region's economy is an important criteria to consider before looking at the detail of particular companies. "If a region is looking viable top-down, then you can find opportunities within that," James says. "Then you’ve got to look at thinks like valuations: Is all the good news priced in?"

Pereira agrees: "You need to look if a country will deliver some upside. So look at some key indicators, judge GDP, the regulatory environment and looking broadly at economic factors."

It is also important to separate the reasons why a company may appear to be doing well but is in fact operating in industries that are overcapitalised or protected by government policies. "So it comes down to the detail," says James.

James says countries that are doing well have a good domestic story, with strong consumer staples and food production sectors. "In the short-term investors should seek these but on the edge, rotating money out of defensive stocks and into more unloved stocks that will make money in 3-4 years time."

How much to invest regionally?
Those investment managers who believe in this style say they are up against it when it comes to encouraging investors to invest regionally. "The biggest struggle is there is very often someone who does not have all the information and will imply keeping money at home is somehow safer," Pereira says.

A version of this article appeared earlier this month on Morningstar.com.au.