In many regions of the world, national borders are rapidly becoming an irrelevance for fund managers...
In many regions of the world, national borders are rapidly becoming an irrelevance for fund managers chasing top performing stocks. Around the globe, the emphasis is shifting from country analysis to sector analysis - Europe is a prime example of the change taking place. But there is one important region where this sector emphasis is still inappropriate - the Asia Pacific region.
Unlike Europe, the Asia Pacific region does not operate as a single market with a single currency. There are no centralised political and economic institutions and, as a result, there is no region-wide economic policy. The countries that make up the region have divergent economic cycles, with Korea leading a strong recovery from the crisis in 1997-8, and the Philippines and Thailand lagging behind.
Thus, in the Asia Pacific region, a company's domicile is still the most important influence on its share price and country based analysis remains the most appropriate way of selecting stocks.
But the economic environment is not the only difference. A number of other country specific factors can have a dramatic influence on stock market performance within the Asia Pacific region. For example, share prices can be sensitive to local politics. For example, tensions between China and Taiwan. So far, periodic outbursts of tension have created good trading opportunities. Selling when consensus is ignoring possible tension, and buying during wars of words has been a very profitable strategy.
Less visibly, but no less importantly, legal and regulatory frameworks differ significantly. In some countries, such as Singapore, the rule of law is set down clearly. The opposite is true of China where there are many grey areas in which there appear to be no rules until the government decides otherwise.
Regulations can have a similarly dramatic impact on profits, although some industries, such as utilities, are more sensitive than others. In Hong Kong returns for electricity companies are dictated by a formula linked to capital investment, so it is easy to work out how profitable they will be. By contrast, in Korea, returns are sensitive to the tariff an electricity company can charge. Tariff increases require government approval and if an election is approaching and inflation is high, the government can order companies not to hike their prices.
Wide differences in terms of economic development, political situation, legal framework and regulatory environment mean share prices of Asian companies continue to be influenced far more by the country in which they operate than the industry to which they belong. But this does not mean sector analysis has no role whatsoever to play in stock selection within the Asia Pacific region, or country analysis will always be the primary tool. For example, a sector approach is already appropriate for industries where a high level of specialist knowledge is involved, such as IT. Analysing the fundamentals of companies operating in these sectors requires a high level of specialist knowledge.
In certain areas, industry liberalisation is occurring and trade barriers are coming down. Notably, China is about to join the WTO which means that it will have to lower import tariffs and let in foreign companies.
In addition, cross border mergers and acquisitions have accelerated since the economic crisis and this is an important consideration. Many distressed companies have been taken over by foreign competitors and this has to be taken into account.
Car manufacturer Astra in Indonesia has been taken over by Cycle and Carriage in Singapore, while Hong Kong power company CLP Holdings has taken a big share in YTL in Malaysia. An investment approach that is purely country based would miss out on the implications of such M&A activity.
Bearing these factors in mind, it is hardly surprising that research from Morgan Stanley has shown the influence of country factors on share price movements declined slightly during the 1990s.
Between 1992 and 1996, 93% of stock price movements were dictated by country factors with sector factors accounting for the remainder. Between 1996 and 1999, only 85% of stock price movements were driven by country factors.
But while the influence of sectors is increasing, enabling fund managers to adopt a more consistent sectoral approach across countries, we are a long way off seeing sector driven analysis becoming the predominant approach in the Far East.
If country factors were ignored, fund managers would not be able to conduct top down analysis which takes into account macro economic factors such as liquidity, economic cycle and politics. This remains vital in the Asia Pacific region.
With sector based analysis, there is not enough knowledge of the political and economic outlook to make a top down assessment. Even in areas such as telecom, media and technology (TMT), where some Far East fund managers are now introducing an element of sector analysis to their research, country factors still have a huge impact on share prices, as the following two examples demonstrate.
Taiwan-based United Microelectic Corporation (UMC) and Singapore-based Chartered Semiconductor both manufacture customised electronic chips for third parties such as Sony, Motorola and Ericsson. Three companies dominate the global market in this sector and all of them are based in Asia. Although UMC and Chartered Semiconductor are similar companies, their share prices performance has been wildly divergent this year. Over the year to date, Chartered's share price has risen 25% whilst UMC has fallen 14% (see graph 1).
The huge underperformance of UMC was mainly due to political tensions in Taiwan. The stock took a heavy hit in February and March in the lead up to the national elections when political tension with neighbouring China resurfaced. Sentiment turned against the Taiwanese stock market at a time when appetite for TMT stocks