By Robert Barker Mutual-fund researchers at Morningstar call them the Unloved. These are the least-popular fund categories from the previous year, the ones investors couldn't yank money out of fast enough. Funny thing is, by Morningstar's reckoning, the Unloved stand a good chance over the next three years of outperforming the average stock fund. Since 1987, the Unloved have managed that feat 75% of the time.
What was unloved last year? Everything Asian. So I decided to check in with one of the steadiest Asia hands, G. Paul Matthews of Matthews International Capital Management. The $250 million company runs a family of six no-load funds, all focused on Asia, including its broadly diversified Matthews Pacific Tiger (MAPTX). Last year, the fund dropped more than 23%, good only by comparison to its benchmark index, which sank nearly 12 percentage points more. Through Jan. 23, the fund is up 16%.
To find out what Matthews makes of Morningstar's bet, not to mention what he and his partner, Mark Headley, are buying and steering clear of, I spoke with them by phone this week at their San Francisco office. Here are edited excerpts of our chat:
Q: What do you make of Morningstar's thinking on Asia funds?
Matthews: Clearly, there's an argument that market bottoms are made when everybody's the most pessimistic. The last quarter of last year would certainly qualify as a period of maximum pessimism for Asia.
Q: Does that mean your funds suffered outflows?
Matthews: We suffered outflows, particularly in December. I think a lot of that would've been tax-loss selling, but nevertheless some of it was certainly people who'd taken an optimistic view at the height of the crisis in late '97 or early 1998, thought they had got it right in 1999, and were disappointed to see a lot of it given up at the end of last year.
Q: Leaving Morningstar aside, what do you think the prospects are for American investors in Asia today?
Matthews: I think you've got to distinguish between the rest of the region and Japan.... Japan is an aging, mature economy, struggling to restore growth, and the rest of the region is characterized as younger economies coming out of relative poverty and enjoying for the first time the benefits of the market.
Q: Go on.
Matthews: To us, the sight of Kim Jong Il from North Korea touring the Shanghai stock exchange with [China's] Zhu Rongji to learn about how the market economy works is such an extraordinary thing to witness after 20 years of being asked why the Korean peninsula wasn't about to explode in flames.... So, yes, absolutely, there are tremendous opportunities for U.S. investors, particularly at a time when sentiment toward Asia is so universally negative.
Q: From your family of funds, which has the most opportunity over the next couple of years?
Matthews: The Pacific Tiger Fund, which is our regional equity fund, with exposure everywhere but Japan. It probably offers the best balance in the region for a long-term, capital-return-oriented investor, from the U.S. perspective.
Matthews: Our single-country funds I think have tremendous potential, but they're extremely volatile.... If somebody has got a particular bent on investing in China, I think our China fund offers great exposure to the Chinese equity market, but you know it's going to be a pretty volatile vehicle....
Headley: It's more like buying a stock than buying a fund. The Pacific Tiger Fund gives great exposure, significantly lowers the risk through diversification, and as bottom-up stock pickers, it's a great universe that we've been working in for years and years.
Q: Speaking of bottom-up stock picking, let's talk stocks. Favorites?
Headley: I'd say Legend Holdings has to stand out as probably our preeminent China play. It's the largest manufacturer and distributor of personal computers in China. While you can talk about PC growth slowing in the U.S., nobody's talking about it slowing in China for years to come. Although the technology is obviously going to evolve very quickly, Legend is selling literally millions of computers in China, with distribution throughout the country, great branding, and a well-run company. Not inexpensive, but with great growth prospects.
Matthews: We also like the other contender for the No. 1 PC distributor in Asia, which is Samsung Electronics. I think also the whole wireless area in Asia is probably more attractively valued than some of the wireless plays in Europe or developed countries, and the take-up there is very rapid. Obviously, we're intrigued by NTT DoCoMo's talks with and possible tie-ups with other Asian cellular companies because of the chance that Asia will continue to lead the world in wireless data.
So [we like] companies like KT Free Tel in Korea. Even, dare I say it, I-Cable in Hong Kong, which is primarily a cable-TV operator but is also involved in broadband. Hong Kong is an ideal city for these kind of operations because of huge population density and everybody's living in high-rises.
Q: What stocks are you staying away from?
Headley: Property companies.... The property boom in Asia ended in a bust, and it's still generally not as exciting, and we don't see it as a real organic-growth story in the coming years.
Matthews: We're wary of lots of big petrochemical conglomerates in the region, where their balance sheets are highly leveraged and they're highly exposed to the cycles.
Headley: And we've crossed Malaysia off of our list, despite having run money there for years and years, [because Malaysian leader] Mahathir introduced capital controls and locked up our money. That was a cardinal sin in our book, and until the government renounces that policy, we've been unwilling to go back.
Matthews: Our biggest fear is capital controls, and the tendency to impose them at whim is scary to us.
Headley: We can live with losing money, but having it locked up....
Matthews: And similarly Indonesia, where we don't like the environment right now...particularly the prospect of capital controls there, which is ever-present for as long as this currency is as vulnerable as it is.
Q: Japan is a different and separate case. What do you make of the outlook there?
Headley: The domestic economy doesn't look terrible. There are lots of mixed signs on the economic front. Things aren't doing great, but they aren't necessarily doing that badly. Everybody kind of panicked in the last quarter, said it was going back into recession. That remains unclear. What you've got on the one hand is the political system that remains in this sort of endless state of crisis.
Q: And on the other hand?
Headley: Corporate restructuring is moving along, and obviously it would be much better if the corporate restructuring were being backed by an effective government. But it's still occurring on a company-by-company basis across Japan. Investors are just terribly wary, both domestically and internationally.
Q: Will it never change?
Headley: There's also enormous apathy within the domestic population. I mean, we all talk about Japan's lost decade, but as far as the average Japanese citizen is concerned, they haven't lost their jobs. Everything has gotten cheaper. They can buy nice Chinese-manufactured clothes at a fraction of the price they would've paid for the same thing five years ago, so their spending power is actually increasing. Does it have to get worse before it gets better? That's one of the questions we ask ourselves.
Q: How do you invest your fund focused on Japan?
Headley: We believe the financial system in Japan is changing for the better, largely driven by foreign acquisitions. You have tremendous foreign multinationals in Japan, and you also have major reorganizations of the domestic banks. So we've got a big bet on financials, and that is primarily the securities companies. They don't have the debt problems that the banks still struggle with. When this market turns around, and with Japan's vast savings gradually being mobilized in a way that they haven't in the past, I think [the securities companies] are great long-term ways to participate in Japan.
Q: One or two names?
Headley: The two large-caps are Nikko Securities and Daiwa Securities.
Q: What else?
Headley: Companies are really driving domestic [information technology] spending. Japan, as most people know, is far behind the U.S. and Europe in spending on IT. [One investment] we have is OBIC. It's a relatively new company, providing IT services across Japan. Another company that has effectively positioned itself in the forefront there is NEC, which still has a big chip business, but increasingly they have geared their business toward domestic services in the technology sector.
Q: You also like some retail stocks?
Headley: Some [companies] are delivering products to the Japanese consumer in a more effective and more efficient manner. A couple of examples would be Fast Retailing and Don Quixote, both introducing new types of chains for consumer goods in Japan and doing so quite successfully.
Q: Finally, let me ask you about the Philippines, where we've had some political action. Are there opportunities there?
Headley: Our Tiger Fund has had Benpres Holdings for a long time, with exposure to the media businesses there and infrastructure, but it's difficult. What are the core industries of the Philippines? They really don't have one.... Indonesia, Thailand, the Philippines have had a very hard time attracting investments, convincing people that their domestic institutions weren't corrupt.... I'm glad we've got a little money there, but I'm not running into this. Barker covers personal finance in his Barker Portfolio column for BusinessWeek. His barker.online column appears every Friday, only on BW Online.
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