Fidelity benefits from local Asian knowledge

The past decade has been a time of remarkable change in Asia. From the difficulties of the financial crisis of the late 1990s, it has developed into a resilient, fast-growing and exciting region.

Widespread corporate restructuring, regulatory changes and improving domestic economies have given rise to a new generation of world class companies that are increasingly capable of delivering bumper returns for investors.

The Asia of today is a powerful global force, with dominant positions in industries as diverse as car manufacturing, semiconductor production and textiles.

But this transformation hasn't come as a surprise to Fidelity. The investment house spotted the region's long-term potential many years ago, and its subsequent decision to invest heavily in the necessary resources has been vindicated.

Since opening its first Asian office in Japan back in the late 1960s, Fidelity International has gone on to establish bases in Hong Kong, Australia, India, Korea, Singapore and Taiwan. Including Japan, it now boasts a team of over 100 investment professionals in the region who look after more than $60bn of assets and visit hundreds of companies every year.

Fidelity's dedicated army of investment professionals provides an unrivalled level of coverage across the region and this is highlighted by the strong performances delivered by its fund managers.

While the benefits of Fidelity's expertise within Asia is evidenced by its extensive range of funds, the company's approach to investment management is, perhaps, best illustrated by three specific portfolios that are focused on the region.

As is the well-established Fidelity way, the South East Asia fund, the China Focus fund and the India Focus fund are all managed by former Fidelity investment analysts who have been promoted through the ranks.

This background gives the managers a unique ability to forensically analyse companies, the knowledge required to question company management teams and a valuable insight into different sectors.

Between them, the managers at the helm of the aforementioned funds - Allan Liu, Patrick Lo and Sandeep Kothari - have over 30 years of investment experience, during which time they have had experience of a wide range of different disciplines.

So what makes this trio believe that Asia is such a compelling investment story?

For Allan Liu, who has managed the Fidelity South East Asia fund since August 2003, it is the fact that leading Asian companies now have strong balance sheets, sustainable competitiveness and the ability to sell their products at home and abroad.

"A major phenomenon in recent years has been Asian brands becoming major global players, such as Samsung and Hyundai," he says. "Companies are now striving for excellence which - excluding those in Japan - most haven't done for 100 years."

As well as establishing itself as one of the world's leading manufacturing bases, the new-look Asia has also benefited from billions of dollars worth of investment which has been pouring into the region for many years.

This cash has been used to radically improve the infrastructure - which is such an important part of a developing economy - and to replace antiquated financial systems with state-of-the-art alternatives.

However, that's not to say the region is totally risk-free.

"We still regard most Asia (ex-Japan) markets as emerging and there are still gaps between here and the developed western markets as far as standards of regulation and corporate governance are concerned, which is why it's important to have local research specialists." says Liu. "The region is also very sensitive to the global economy which means it would be impacted by a worldwide recession."

There are also country-specific risks, suggests Sandeep Kothari, who manages the Fidelity India Focus fund. "Politics is the biggest risk in India and if the government fell, this would trigger a short-term correction in the markets," he says. "Whenever there's any political instability, the pace of reforms gets pushed back."

Even so, a combination of the unique opportunity to invest in large, rapidly growing economies which have the benefit of young, educated workforces, and Fidelity's stock picking expertise, honed over many years, makes Asia extremely appealing.

Broad appeal

The £559m South East Asia fund offers investors access to the growth of the region through a diversified range of industries and countries.

Its Hong Kong-based manager, Allan Liu, tends to focus on mid and large-cap companies, particularly high quality stocks in which there is a relatively low risk of them being beset by financial or business problems.

"I usually try to pick stocks which can grow faster than either the market or their sectors, but which are also reasonably valued," he explains. "I am aware of the fund's benchmark, but feel it's more important to look at the merits of individual companies, which means any geographical or sector biases are a result of stock selection."

On average, Liu observes a one-to-two year investment time horizon, in order to give the fundamentals time to be appreciated by the market, and likes to be comfortable with both the management team and the company's core competence before he invests. "I need to know that any competitive advantages are going to last for some time without the company being caught up by its rivals," he adds. "Meeting management in person helps this process because you can learn a lot about their company - even through their body language."

Samsung Electronics, he suggests, is typical of the company he likes in his fund. "Ten years ago I don't think anyone could have predicted that it would be as strong as it is right now," he says. "It has grown from a commodity-type manufacturing company into one that is now a major brand and making world class, quality products."

Liu, who also manages a range of Fidelity's offshore Asian regional funds, has been with the company since joining as an investment analyst in 1987. For the past 16 years he has been a portfolio manager and believes Fidelity's dedicated, localised approach to the region has been a driving force behind its success.

"Having local analysts is important because it's extremely difficult for managers to make effective decisions when they're sitting 1,000 miles away from a particular market," he explains. "For example, we have been able to pick up more money-making ideas since we established our Korean office because we are in closer touch with the local sentiment."

Perhaps more surprisingly, he adds, is the fact that many of these companies are still offering plenty of potential. Despite the impressive operational and financial changes that have taken place, there is still a sizeable valuation gap between Asian markets and more developed alternatives in other parts of the world.

"There's still a perception that Asian business models are solely built around doing something cheaply which won't be sustainable in the long-term when rivals undercut their prices," explains Liu. "However, many of today's Asian companies have got access to very good supply chains, can deliver/execute on time and still offer impressive cost efficiencies."

It is for these reasons that he remains confident that the region can continue to deliver the goods for investors. "Asian markets are still subject to the volatility of developed stock markets, but as long as we are able to invest in the long-term winners, there should be meaningful rewards for our clients," he says.

Star of India

India may well have hit the headlines across the world in recent months due to its benchmark BSE Sensex index hitting all-time highs, but the country is certainly not an overnight success story.

Years of gradual restructuring - both at a corporate and economic level - have made it an attractive place for investors and this is a trend that Sandeep Kothari, manager of the Fidelity India Focus fund, expects to continue.

"India is being discovered," he says. "Company profits have been very strong and there have been a lot of capital inflows. The combination of these two factors has resulted in our stock market hitting new heights."

The stated objective of Kothari's fund is to provide long-term growth by investing in securities listed in India, as well as non-Indian that derive a significant portion of their earnings from the country.

The £2.15bn fund, which was launched in August 2004 and is benchmarked against the MSCI India Index, will look to invest across the market cap scale, although there will often be a higher allocation in small and medium-sized businesses.

"Our stock picking approach is very much bottom-up," explains Kothari. "We're looking for globally scaleable businesses which offer unrecognised growth potential at a reasonable price."

The quality of the management is also of paramount importance. "It's vitally important to be invested in companies where the management is focused on generating returns over the longer-term," explains Kothari. "We will take a close look at the company's track record, its sustainable returns and the opportunities for growth, before we make a final decision to invest."

Meetings are held with the managements of all the stocks held in the portfolio - which is usually between 90 and 110 at any given time - while the top 500 companies in an investment universe of 4,500 will be regularly monitored.

Kothari cites Suzlon Energy, which currently accounts for 3.3% of his portfolio, as a prime example of an investment in which he has faith. "It manufactures wind turbines and benefits from good growth, good technology and a good management team," he explains. "It is also a globally scaleable business." Other prominent names among his top 10 holdings are Infosys Technology and Reliance Industries.

In recent years, changes to the economic fabric of the country - particularly in regard to infrastructure improvements - have significantly helped the development of such impressive companies. As a result, pressure is mounting on the government from the business community to make overhauling rigid employment laws the next step.

"At the moment, if you have more than 1,000 staff, then hiring and firing people is not easy, so there's been talk about making the regulations more flexible," explains Kothari.

"It's a slow process, but if it was to happen then it would be of enormous benefit to industries such as textiles. Not only could it help increase employment, but it could also help boost the levels of growth."

He is, however, realistic about when these changes are likely to take place. "India's a large country with a population of a billion people which means it moves at its own pace," concedes Kothari. "Looking ahead, a lot more investment is needed, but things are definitely moving in the right direction."

In fact, it's this potential that probably makes India such an attractive proposition for investment portfolios, particularly for higher-risk investors who want significantly better returns than can be generated from either cash or fixed income.

"India is a long-term structural growth story that cannot be ignored," adds Kothari. "There may be a few hiccups along the way, but it's an emerging market that's going to evolve into a mature market over time. That's the growth story that people can participate in by investing in India over the long term."

Made in China

In many ways, China remains the focal point for the entire region, according to Patrick Lo, manager of the $366m Fidelity China Focus fund.

The combination of improving trade links - both within Asia and overseas - stock market restructuring and general improvements in the overall infrastructure, he suggests, have helped create a sustainable growth story for the country.

"From an equities point of view, we think China will go from strength to strength over the next couple of years," says Lo. "We might see some adjustments, but I don't think they will be major corrections and that means there should still be plenty of investment opportunities for us."

The aim of Lo's Fidelity China Focus fund is to achieve long-term capital growth by investing in Chinese securities listed in China or Hong Kong, as well as non-Chinese companies that derive a significant portion of their earnings from China.

Benchmarked against the MSCI China Index, the portfolio invests in a wide variety of stocks - even down to mid and small-cap names, as long as they have solid corporate fundamentals and sustainable earnings growth.

"My investment philosophy is to closely analyse sectors that I want to be involved in and then choose the very best stocks within it," explains Lo. "The key factor for me is the management. I like them to demonstrate they have the vision, strategy and financial strength required to be successful. It also helps to have a consistent strategy and an ability to deliver consistent performance - yet still be on a reasonable valuation."

Favoured sectors at the moment include financials, which account for around a fifth of the fund, consumer discretionary stocks which make up 15.2% and energy companies which account for 13.4%.

Lo currently holds between 65 and 70 stocks, with the largest holding of 6.8% being in China Life, a leading insurance company. "This stock fits most of our investment criteria and its valuation has also been quite compelling," he explains. "Not only is premium growth strong, but profits are looking good as well."

The number of companies from which to choose, he adds, has been one of the defining factors of the last 10 years. "It used to be the case that only companies involved in heavy engineering, steel or cement would list on the stock market, but that's all changed now," he explains. "It's a lot more diversified, with sectors such as banks, insurance, telecoms and oils all being represented."

However, the government's influence over a number of them is a key consideration when it comes to putting together the portfolio. "This is a big issue because sectors such as telecoms, energy and financials are still heavily regulated by the state," says Lo. "In contrast, others such as manufacturing have been opened up for a long time and there's now very limited government influence over them."

Looking to the future, domestic consumption is one area which Lo believes is ripe for improvement, particularly given the fact that salaries have been rising sharply over the past couple of years - without much impact upon the inflation figures.

"China has come a long way but it's still not yet the finished article," says Lo. "In some areas, such as manufacturing, it's very advanced, while there's also been a large increase in the number of world class highways in the country. However, changes are still taking place both in the financials sector and in the stock market and I would expect these to continue bearing fruit over the coming years."

Fund sizes as at 31.06.06. Portfolio holdings/allocation as at 31.12.05.