Alpha Hunters: Viewing Asia from Top-Down and Bottom-Up

Working out of Hong Kong, Khiem Do is the head of the Asia Multi Asset Team, a member of the Global Multi Asset Team, and a member of the Strategic Policy Group, of Baring Asset Management. He joined Barings in 1996, arriving from Citicorp Global Asset Management in Sydney. We spoke to him on the evening (HK time) of January 26, the first trading day after the Chinese New Years’ holiday. We began with a question about the start of his tenure at BAM.

AAA. You joined Barings only a year after the Nick Leeson crisis. [In ’95 Leeson fled after  losing $1.3 billion on unauthorized trades, and these losses forced the sale of Barings to the Dutch bank ING for £1.] What was the climate at BAM like when you joined?

Khiem:  The only days when it was a bit chaotic were the two weeks right after Leeson’s flight. But after that, things quickly went back to normal. In fact, ’96 was quite a very good year for the Baring Asset Management group.

AAA: Not long thereafter you were facing the Asian financial crises of 1997-98. Could you tell us about those days for Barings? Stepping back, was it valuable experience for the events of and since 2008?

Khiem: This was a “mini-me” version of the global financial crisis of 2008 in the U.S., and now spreading to Europe. But, it isn’t the kind of experience you want to acquire on a frequent basis!

Top Down

AAA: How would you describe the Asia Pacific Fund Inc.?

Khiem: It is a pure Asian equities portfolio. We can leverage the fund up to about 15 percent. We can hold cash up to 30 percent of our portfolio, should circumstances warrant for such an action.

AAA: How do you generate alpha for your investors?

Khiem: Alpha is generated by combining two approaches, bottom-up stock selection and top down macro thematics. As far as stock selection is concerned, we have 18 analysts and fund managers combing through the region for good ideas and opportunities. The average experience of our fund managers is about 12 years. From a macro schematic viewpoint, we have a Strategic Policy Group, which provides the big macro picture, including where the global risks and opportunities are, to all investment professionals at Barings, who then will analyze how the macro thematics would impact on their regional portfolios. Our Asian equities team have delivered strong alpha to our investors over the past 5, 10 and 25 years by integrating both the bottom-up and top-down perspectives.

AAA: There has been a good deal of speculation, both bullish and bearish, about the People’s Republic of China. Can you give me a big-picture view of where they are and where they’re heading?

Khiem:  In 2009, the government accelerated a number of mega-projects, funded mostly by bank lending. This did have some negative effects. Some of the local authorities got carried away and it was clear that there was going to be a negative return on these projects for awhile. As that played out, the government had to pull back and the PBOC tightened monetary policy. A number of offshore investors (especially hedge funds in New York and London) became convinced China was a boom-and-bust story, and the bust was at hand. They also believed that the Chinese banking system itself had a hidden bad debt issue.

AAA: Are those worries justified?

Long and Short

Khiem: European debt crisis remains the biggest macro risk. United States growth sustainability is second. The recovery there has been reasonably strong, but whether it will last is yet to be seen. China is third as a macro-risk. There are appropriate concerns about China, including the health of its banking system, but they have been over-emphasized. We anticipate a soft landing for China in 2012.

AAA:  In recent days, the Hang Seng has moved sharply upward. What do you think is fueling this move?

Khiem:  If you want to find the drivers of the upside you can point to the cut in the central bank’s reserve requirements in China, and the stronger-than-expected Q4 GDP and bank lending data. Recent measures implemented by the ECB in Europe may have made the crisis there seem more manageable, and that is good news for the Hang Seng. Also, the U.S. Federal Reserve’s announcement on the 25th that rates will stay low until 2014 is a nice” lai-see” (red packet) for the start of trading after the Chinese New Year celebrations for Hong Kong. The Year of the Dragon opened in its true fiery style.

There is another consideration that is in our view very important. Hedge funds in both New York and London have been short on China and Hong Kong. Very short. The Hang Seng is a liquid market, which has made it easy for them to take a big short position. They’ve been waiting for the big melt-down, which never came. Some of the day-to-day upward move of recent days has been a matter of the shorts covering their positions. That action has been fast and furious. Long only funds have decided that they’re underweighted in China, which has added to the excitement.

Bottom Up

AAA: The Korean electronics giant Samsung is in your portfolio. That company is involved in what looks like a high-stakes patent rights war in jurisdictions around the globe, especially with Apple. How do such legal considerations factor into your investment analysis?

Khiem: Patent issues arise all the time. Apple and Motorola are also in a continuous fight over patents. This is a sort of “legal dance”, in which the dancers from time to time change partners. Apple’s lawsuit asserts that Samsung used its touch screen design — but that is the sort of thing that can be changed quickly, which is what Samsung has already done.

What Apple hopes to get is some portion of a revenue stream from the accused party, but the real investing significance of such ‘dancing’ is immaterial.

AAA: I also see that in country-by-country terms you have relatively small stakes in Malaysia and Singapore. Under what circumstances could that change?

Khiem: In Malaysia we only like a few stocks. Most of the solid companies there are quite pricey already. Of course, if the macro situation changes, then our allocations will change.

Singapore market growth is expected to be sluggish this year. Combined with a high inflation issue, one ends up with a stagflation situation. Again, we have found only a small number of stocks we like.

We do see opportunities for growth in Korea, China, Indonesia, Thailand, Philippines (although trading liquidity could be an issue) and, to a lesser extent, in India.

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