Harvesting investment returns in Asia
Prior to the recent global financial crisis, OAM Asian Recovery Fund had experienced three peak-to-trough declines of 10-20 per cent, but nothing worse. In the third quarter of 2007, we felt that Asian equity valuations were high and accordingly, we increased the Fund’s cash to 15 per cent of assets.
The Fund’s cash had never been so high. In spite of raising this level of cash, it was far from sufficient given what ensued between late 2007 and early 2009. Even though the causes of the global financial crisis were not rooted in Asia, equity markets in Asia fell more than US and European stock markets and OAM Asian Recovery Fund’s NAV per share fell by nearly 50 per cent peak-to-trough.
We were fortunate in distinguishing ourselves from most funds by having net subscriptions during this deep drawdown. I attribute this to our sophisticated client base, and it probably gave reassurance that I told clients that I was “eating more of our own cooking” during this depressed period. We were therefore able to invest at ultra-cheap valuations these subscriptions plus most of the cash we raised near the market peak.
Determined not to repeat such a large draw-down and test our clients’ fortitude again to this degree, the directors of OAM Asian Recovery Fund recently agreed to alter the Fund’s cash level much more dramatically going forward. The Fund’s prospectus was recently amended to reflect this change. This will allow us to make the high volatility of Asian equity markets our friend rather than enemy.
Asian equity markets have had four busts in the past 15 years – the Asian financial crisis, the bursting of the internet bubble, the SARS outbreak and the recent global financial crisis. Asian equity markets are volatile because domestic retail investors follow momentum on the way up and down. This stems from the seemingly insatiable Chinese gambling instinct as demonstrated by the remarkable success of the new casinos in Macau and Singapore. This is exacerbated by “hot money” invested by foreigners flowing into and out of the region with each bull and bear market cycle.
This brings us to the million dollar question: where are we today in the market cycle? If we depict stock market valuations as swinging like a pendulum between 3 o’clock which represents very cheap, 9 o’clock which represents very expensive, and 6 o’clock which represents fair value, I reckon that Asian equity markets are currently at around 7 o’clock. The momentum of lots of liquidity globally and record low interest rates are pushing it towards 9 o’clock. Every fund manager in Asia with whom I recently shared this analogy broadly shares this view of where Asian markets are today. Our view is that it is too soon to raise a lot of cash, but that day is approaching.
Money supply and bank lending in China exploded during the past two years and that is likely to result in problems down the road. Every January, Fidelity Bank in Cayman hosts a one-day conference called Cayman Business Outlook which always has excellent speakers. One of the speakers in January 2011 will be Michael Pettis who is a professor at Peking University’s Guanghua School of Management where he specialises in Chinese financial markets. Pettis writes a very interesting blog and is likely to point out some of the coming problems in China.