Is the Chinese Tiger still roaring?

From time to time, Morningstar publishes third party content under our "Perspectives" banner. If you are interested in Morningstar featuring your content, please contact Online Editor Holly Cook (holly.cook@morningstar.com). Here, the Association of Investment Companies reviews the fund industry's outlook for China and Asian emerging markets in 2010.

As the Chinese New Year approaches, the Association of Investment Companies (AIC) has collated investment company fund manager views on the prospects for China and the wider Asian emerging markets. Emerging markets were tipped to be the top performing region in 2010 in the AIC’s fund manager poll at the end of 2009 and interest in the region has continued into 2010. China has been at the forefront of the news so far this year with Fidelity’s launch of a new Chinese investment company, however with the Chinese belief that the tiger is a sign of bravery, is investing in the region just for the brave or is China still the country to watch?

What are the prospects for China?
In general, investment company managers are optimistic about China, believing that it has weathered the crisis well and should be set for a period of continued and rapid growth. There is however some concern that China has been growing too fast, which in turn could lead to further problems. Hugh Young, managing director of Aberdeen Asset Management Asia and lead manager of various Aberdeen Asian equity investment trusts, is cautious on China’s prospects due to the rapid rate of economic expansion.

Mike Kerley, manager, Henderson Far East Income said: “We are positive on the prospects for China and believe it will be the driving force for Asia and to a lesser extent the rest of the world in 2010. Its strong fiscal position and ability to get government policy into the real economy quickly makes it better positioned than most to ride out any volatility as the year progresses.

“We expect GDP growth will be between 8% and 10% in 2010, led mainly by government investment but supplemented by consumption growth and a recovery in exports. The main risks lie in too much growth rather than too little which could ultimately be inflationary and lead to more aggressive policy response than we currently expect.”

Emerson Yip, a manager of JPMorgan Chinese Investment Trust believes that investors need to have faith in the Chinese government: “China in our view has managed its economy remarkably well--from brief recession in the early part of the year to massive stimulus and now strong domestic demand. Investors have not been able to accept this readily – worrying about the strength of the economy, the ability of the Chinese government to deliver stimulus and now about new bubbles and excess capacity.”

Mike Gush, Portfolio Manager for Pacific Horizon, also believes that the prospects for China look strong: “The re-emergence of China remains one of the most important investment themes of our time. Unlike the debt-ridden West, China has emerged from the global financial crisis in a position of strength not weakness. Investment and consumption are key growth drivers and we continue to be excited by what is undoubtedly fantastic potential. At the same time the opportunity set available to us continues to increase and we believe that valuations remain attractive given the outstanding prospects.

John Millar, manager, Martin Currie Pacific said, “China has had a ‘good crisis,’ but the next test is whether it can become less reliant on public spending. We’re in the early stages, but with exports and imports improving, there are some encouraging signs here.”

Hugh Young is more cautious than the other managers: "China's message has always been that it needs 8% growth to absorb new entrants to its workforce. However, achieving such growth requires very expansionary policies that can at times cause overheating. Excessive credit growth almost always leads to rising bad debts, which in turn dim economic prospects. In China's case the question is more "when" than "if"."

Is China the country to watch for 2010?
This time last year, managers clearly thought that China was the country to watch. This opinion is echoed this year, however the mangers have noted that it is important not to forget some of the other countries within the Asian “emerging markets” spectrum such as India, Korea and Japan.

Martin Currie's John Millar said: “Given China’s sheer size, fiscal clout and importance as a market for other Asian economies, it’s still the key to Asia. But it’s important not to lose sight of opportunities elsewhere. Markets such as Korea and India have plenty to offer. And nor should we forget the largest Asian market: Japan--which is of course a key beneficiary of Asian growth.”

Mike Gush of Pacific Horizon said, “With much focus on China, it is perhaps easy to overlook other emerging markets. India is another populous nation with bright prospects and abundant potential. Historically, it has been constrained by a bureaucratic political system and enormous amounts of red tape hindering business. However, the government now has a genuine mandate for change. We believe this is key to enable realisation of the potential and we remain very optimistic about the outlook for those Indian companies with true competitive advantages.”

Hugh Young added: "China is always the country to watch because it has such an influence over the rest of the region. But this does not necessarily mean its equity markets will perform well. It should be noted that since the early 90s the MSCI China index has fallen 40% despite the economy expanding around five times. Top line growth does not always filter down to shareholders."

Optimism in emerging markets for 2010
While the West, and in particular the indebted UK, is struggling to emerge from the recession, emerging markets are in a different position having weathered the “financial storm” well and have minimal debt levels both at a national and consumer level. Again Hugh Young is more apprehensive than the other managers but believes investors’ attention will refocus on strong defensive companies.

Henderson's Michael Kerley believes Chinese shares are currently good value compared to the rest of the region, however he is not ruling out other areas. He said: “Emerging markets should do well in 2010 and the years following. The last ten years have all been about the US consumer--the next ten years will be about consumption in emerging markets. The West needs a prolonged period of de-leveraging following a credit binge, which will dampen growth. The challenge for emerging markets is to mobilise excess savings into consumption and investment to fill the hole left by a sustained period of below trend growth in the developed economies.”

John Millar believes there is optimism for emerging markets. He said: “Given the huge influx of liquidity and the nascent recovery in demand, emerging markets should continue to outperform their developed counterparts this year. But the real opportunities lie in domestically focused companies and those exporters that have managed to win market share during the crisis. Companies that have been ‘rescued’ by the various stimulus plans and fiscal largesse of the last 12 months still look distinctly unsafe.”

Again, Hugh Young is a little more apprehensive. He said: “While Asian countries outperformed last year, we do not think that the outperformance reflects the fundamental strength of banking systems in the region, nor the low levels of corporate, personal and government debt. However, it is possible that a correction in developed equity markets could impact markets in the region. Sectors are likely to see increasing differentiation. We think that in 2010, investors’ attention will refocus on strong defensive companies such as telecoms and consumer staples."

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