Last week, I had a chance to catch up with an old friend. He is a fund manager for an international asset management firm that has billions invested in Asia.
His firm has offices across the region, supported by a number of analysts who build detailed models for stocks under their coverage and have easy access to top Asian corporations. My friend told me he’s upbeat about Asia but, explained off the record why he thought his firm could only muster “zombie performance”.
His predicament is not unique. Big funds are focused on big markets, invest in big stocks and are served by big brokers. And investors tend to only hear about the big funds as they have superior marketing muscles.
But that’s not how you make money investing in Asia. As far as I’m concerned, the best investments are found in the smaller markets. They’re smaller stocks and they’re researched by smaller brokers or independent advisors.
That’s why I spend so much of my time travelling through Southeast Asia. It’s why I’ve clocked up over 325,000 air miles over the last decade. I believe you need to take a DIY approach to investing. You need to be your own fund manager. You should track the themes you like and buy stocks that you think are attractively priced before the big funds move in.
That may sound daunting. But it’s the best way I know to make money in this part of the world. In today’s The New World I’ll even prove it to you...
The big funds won’t reward you
Asia is gradually taking over the global economy. And many Western investors are looking to buy a stake in this story. Most of them will invest in big funds in the belief that it is the most rewarding option.
I disagree. One simple way to illustrate this is to ask how many Asian funds were able to capitalise by following these top four performing markets in 2012?
• Thailand 35.8%
• Philippines 33.0%
• India 31.8%
• Hong Kong 21.7%
The answer is just a few. Most big funds would be happy to meet the benchmark; the MSCI Asia ex-Japan index, which returned 22.7% in 2012.
To do that they would have to follow the suggested weighting of China 24.3%, South Korea 20.2%, Taiwan 14.2%, Hong Kong 12.3% and others 20.4%.
What’s more, most of the big funds focus on the top 10-20% stocks by market capitalisation. They are missing out on many of the most exciting stories. In fact, a London-based India fund manager pointed out recently that foreign ownership of large-cap stocks has been increasing and is now at a peak of 22%. Small cap exposures have been declining and hit a recent low of 12%. This confirms a narrowing interest in the market.
The other reason why most fund managers miss out on the great stories is because they are worried about their careers. This concern for reputation makes it hard for them to try something new. I’ve seen it so many times throughout my career – analysts and fund managers simply following each other into the same investments and ignoring the truly great stories of the time.
If you've enjoyed what you've read so far, I've got something you'll definitely be interested in.
'The New World' is MoneyWeek's FREE globally-focused weekly email, bringing you the most exciting investment stories from Asia and Latin America.
Sign up here FREE to The New World email
Small top-performing markets
So where should you invest? Well, at the end of 2012, the Asia-Pacific region had 23,279 listed companies with a total market capitalisation of $16.9trn, according to World Federation of Exchanges.
This year among all the Asia Pacific countries, the best performing markets are Laos 19.6%, Philippines 18.7%, Thailand 15.7% and Vietnam 13.3%.
They are relative minnows in terms of market capitalisation. But they are also part of a bigger picture. These booming markets are all members of the Association of Southeast Asian Nations (Asean). A topic which I believe is the most exciting emerging-market story you’ll ever invest in.
Foreign funds, meanwhile, have not participated in these rallying markets (though Laos is difficult to tell due to lack of data). Instead it has been local flows that have done the heavy lifting – Southeast Asians investing in their own future.
Thailand is a perfect example. The most popular fund type is the so-called ‘trigger fund’ which are funds that will automatically redeem and/or switch the units on behalf of the investors when it meets one or more predetermined criteria, often a rate of return. The Thai mutual fund industry is expected to grow by at least 10% this year.
When the region’s economy grows by 4-8% a year governments, corporations and private investors generate cash. This is sticky money. And they will invest in equities, including small and mid-caps. This is the sweet spot for the next few years. And so, Asian money begets Asia.
Small funds outperform big funds
The small size effect is also visible among funds. A study of nearly 3,000 equity long-short hedge funds reveals that small funds outperformed big funds by 254 basis points and 220 basis per annum over five and ten years, respectively.
What was interesting was that the outperformance was most pronounced just before and just after the financial crisis, while drawdowns (drop in value of the portfolio) were in line during the crisis. The outperformance was due to stock-picking, not market direction. And the dispersion of the return was greater than those of larger firms.
The study suggests three potential factors driving the discrepancy in returns:
• The most talented managers opt to start firms rather than work at larger firms. Many managers gain experience in larger firms before launching their own firms.
• Smaller firms have a better opportunity set: based on trading volume, the number of potential long and short side investments declines by up to 80% between $100m and $1bn in assets under management.
• Pressure to perform: smaller firms need to generate performance fee while larger ones derive up to 80% from management fees.
I have several close friends that manage well smaller Asia funds. But they are rare and only known to specialist investors, family and friends.
What does this really mean?
The wealth in the world is moving to Asia. I think the highly indebted UK and other developed economies will mean that investors will have to take a direct and hands-on approach in terms of managing their own wealth.
If done in the right way, I think it can be highly rewarding and a simple exercise.
For example, back in August last year I mentioned Italian-Thai Development (ITD TB) as a great way to play the Mekong boom. It has gained a whopping 128% since then. A big fund either ignored that stock or invested a minuscule amount and opted for the heavy-weight (3.85% in the MSCI Southeast Asia) DBS Group Holdings (DBS MK) which gained a mere 7% during the same period.
As the UK economy coughs and splutters along, I expect to find plenty more fantastic opportunities in this part of the world. In fact, I’ve even given away three great plays in my recent report – just to show you how spectacular the opportunity is here.
You won’t find these plays being discussed in the mainstream media yet. The big funds are only beginning to look at them now. But readers of my Profit Hunter letter got there well ahead of them. And they are glad of it too!
You can find out how to invest here.
• This article is taken from The New World, MoneyWeek's FREE regular email of investment ideas and news from Asia and Latin America. Sign up to The New World here.
Profit Hunter is a regulated financial product issued by Fleet Street Publications Ltd.
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.