Talking Asia with David Urquhart

David discusses how he deals with rising inflation in Asia, what’s driving the IPO boom in the region and talks about some stocks he likes.

At the moment, there is much talk about inflation in Asia, especially in China and India. How big an issue is it when it comes to investing in the region?

China and India are high-growth countries and because of that they tend to have inflation. There are times when inflation spikes but the reasons vary. One type of inflation that people get particularly concerned about is food inflation. Food inflation is usually temporary in nature. It will usually be about a bad crop or a shortage of supply. So I’m not that worried about food-related inflation; it’s usually resolvable. Other factors could be more of a concern. The thing to note is that authorities across the region are taking steps to limit inflationary pressures.

What we focus on when looking at economies experiencing inflation is finding companies with pricing power – those that can boost their prices to maintain their profitability. We try to avoid companies that are price takers; that do not have that ability to raise their prices during inflationary times because their earnings will suffer.

What’s driving the record increase in IPOs in Asia?

The IPO boom is because many companies in Asia are looking to expand their businesses. It gives you an idea of the kind of dynamism that’s going on in Asia. The managers of these companies see growth opportunities and they’re looking to grow their capital and invest that capital to take advantage of the earnings potential that is there in Asia.

The consumption story in China is gaining adherents. How are you playing this theme?

There’s a great thematic in investing in the consumption sector within China because of the strong wage growth that’s coming through. With minimum wages growing 20% and the average wage earner seeing 15% to 16% wage growth, consumers are driving the economy more. People are moving beyond a subsistence lifestyle and for the first time are buying items such as fridges and televisions and so on.

The way I’m taking advantage of this theme is to invest in some Hong Kong-listed companies that have businesses that are growing strongly in China and that are expanding the number of stores they have there. I’m investing in some of the department stores within China as well.

Korea has several global brands. Can China replicate this achievement?

South Korea has developed some great global brands. Companies such as Samsung, Hyundai Motor and LG Electronics have been highly successful across the globe. China has the potential to develop similar brand names over the next five to 10 years. We’ve noticed how much money some Chinese companies are spending on R&D. The fact is that the Chinese companies don’t want to be the low-cost producers forever. They want to add more value to what they’re producing. As they step up that value chain, they will create brand names, locally at first, and potentially globally.

Corporate governance in Asia is a risk. How do you manage it?

Corporate governance in Asia is a challenge that we have to deal with. Our approach is to make sure that we have identified who the management are, how long they’ve been there and who the owners of the company are. We spend time with management teams to understand whether they are just focused on making money for themselves or for shareholders as well. We want to see if there are other agendas that the managements want to achieve – things that might be good for their egos but perhaps not good for the share prices of their companies. Our focus is really to identify companies that are running good businesses and delivering on the potential.

One of the great things happening within Asia is the adoption of international financial reporting standards. That means that you can compare companies within Asia and properly rate Asian companies against global peers. Most of the developed markets in Asia already comply with these reporting standards. Countries such as India and Indonesia are adopting them over the next couple of years.

How important are smaller countries in the MSCI Asia ex-Japan Index such as Indonesia, Thailand and the Philippines?

The smaller countries within Asia don’t get the same kind of profile as China and India but they are a key part of what’s going on in Asia. Indonesia, Thailand and the Philippines are all countries that have got big populations and are achieving improvements in the standard of living. Their GDPs are growing at healthy rates and wage levels are rising. These countries are urbanising. They are microcosms, to some extent, of what China’s already done. We see that to be a reason for investing in some of the companies in these countries.

How is the Fund positioned at a country level?

The Fund is overweight Hong Kong and Thailand while the key underweights are to Taiwan and Malaysia. Hong Kong is favoured at the moment because I see some of the Hong Kong-listed stocks as doing well out of China. The valuations are more attractive and there are fewer regulatory risks with some of the Hong Kong stocks than there are in Chinese stocks. Taiwan’s a mature market, one with a high GDP per capita. The growth rates are still reasonable but a lot of Taiwan’s growth is about exports, either to China or elsewhere. I see Taiwan’s competitors as being more attractive than the companies in Taiwan.

Chinese internet company Baidu is a large overweight in your portfolio. Can you tell us why you are so positive on the stock?

Baidu is effectively Google for China where there’s a good long-term growth story for internet usage. It does internet search and has over 85% market share for search in China. Google is the second-biggest player and Google has said that it is leaving China because it doesn’t want to be censored anymore.

Baidu has around 72% revenue share of search in China. We think given Baidu’s market positioning the company’s revenue share will become more reflective of its market share in search; in fact, even in excess of its market share. We expect Baidu’s market share in search revenues to become more like 85% to 90%, given the company’s dominance in the space.

Another overweight is Hyundai Motors. Can you tell us your investment thesis on this company?

There are three key reasons for owning Hyundai Motor. The first is the company has a really strong base at home in Korea that’s growing healthily. Another is that the company has fantastic exposure to the emerging markets of China, India, Brazil and Russia, where they’re achieving strong market shares. In addition, Hyundai is growing market share in the developed markets thanks to improvement in the quality of the cars and its brand. Market share has risen from around 3% to 8% in Canada, for example. Hyundai’s market share is now around 6% in the US while in Europe it’s grown from around 2% to 4% in recent years.

What can investors expect from Asia in coming years?

I’m optimistic about the outlook for Asia over the next couple of years and over the next five to 10 years as well. We see that Asia will achieve faster GDP growth than the rest of the world. I think that investing in Asian companies is a great way for investors to take advantage of this expected growth. These companies have strong balance sheets and good cash flows. They are investing in their businesses, developing great products and building brand names. We look for the companies that can take advantage of this growth and deliver earnings-per-share growth to the shareholders.