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The Rich Promise of the East

By Palash Ghosh The weak U.S. dollar may tempt some investors to buy into mutual funds or exchange-traded funds (ETFs) that invest in foreign regions with stronger currencies, such as Asia. But that decision may not neatly translate into higher equity returns.

Global currencies and the ways they relate to one another are extremely complex, and experts caution investors not to play a strong currency against a weaker one for the sole purpose of exploiting quick gains. However, given their strong economic fundamentals and undervalued stocks, Asian markets present an appealing place to invest for reasons beyond just currency strength.

"MIXED EFFECT." "The general consensus is that Asian markets are looking very attractive," says Lisa Chen, a portfolio manager at Barclays Global Investors and head of its international iShares group, which runs several Asian-based ETFs. "Asian economies have good underlying fundamentals, including strong balance of payments and current account surpluses," she notes. "There is also widespread belief that Asian currencies are undervalued, and that they will continue to appreciate relative to the U.S. dollar."

Andrew Foster, co-manager of the Matthews Asia Pacific Fund (MPACX) and Matthews Asian Growth and Income Fund (MACSX), notes that a weak dollar does not automatically boost Asian equity prices. "It produces a very mixed effect," he says. "Stocks of Asian exporters often struggle when the dollar weakens and U.S. consumer purchasing power declines. Domestic-oriented Asian companies tend to be stable, or perhaps rise when the dollar weakens."

The weak dollar particularly hurts South Korea -- 40% of its economy is tied to exports -- since it diminishes the competitive edge of such huge exporters as Hyundai Motor and Samsung Electronics.

ROOM TO GROW? Edmund Harriss, portfolio manager of the Guinness Atkinson China & Hong Kong Fund (ICHKX) and the Guinness Atkinson Asia Focus Fund (IASMX), notes that Asian countries are predominantly exporters, and the weaker dollar clearly hurts the value of exporters' revenues when translated back into local currencies. "The weak dollar gives with one hand, and takes back with the other," he says. However, he believes that there is more to like about the region. "My argument for Asia is not the currency play but the superior growth and lower valuations in spite, and because, of the weak dollar."

How far have Asian currencies gained against the dollar? Consider that the Japanese yen, which recently reached a five-year high vs. the dollar, rose 28% against the buck over the past three years through Dec. 31, 2004, including a modest 4.5% gain in 2004. Korea's currency, the won, rose 27% against the dollar over the last three years, while Taiwan's dollar appreciated 10%. Still, these numbers fall far below the 52% surge the euro has enjoyed against the dollar, leaving many observers to believe that Asian currencies have more room to grow.

Currency gains are just part of the total return an investor receives from international investments, "as long as they are invested in unhedged investment vehicles," Chen notes. Barclay's line-up of Asian ETFs are unhedged, which means that the U.S. investor will get both the price return from the equity market, as well as the currency return, she notes. "You will not get this currency gain if you invest in Asian countries like China, Hong Kong, or Malaysia, all of which presently have 'hard pegs' with the U.S. dollar," Chen adds.

EYES ON CHINA. Indeed, several Asian currencies trade at fixed exchange rates relative to the dollar, that is, they are "pegged" to the dollar. Joseph Taylor, emerging markets bond strategist at Loomis Sayles, notes that even the major currencies which are not pegged to the dollar, like the Japanese yen and the Korean won, "are still managed against the dollar and their [central] banks are very cognizant of their exchange rates with the dollar." Still, Taylor says he expects the won and yen to strengthen further against the greenback this year.

A major component of the currency picture in Asia lies with China. There is increasing pressure on the Chinese government to decouple its currency, the yuan, from the dollar. "If China decides to upwardly revalue the yuan, they will likely do so modestly, and this would lead to further upward appreciation on other Asian currencies," Chen says.

Harriss believes that China is reluctant to depeg from the buck because the Chinese economy has been stable and growing since it hitched onto the dollar back in 1994. "They are also concerned about investors taking speculative positions in the currency," he says. "Their aim is to move off the peg as quietly as possible, with minimal disruption to the currency. The pegged currency gives them some competitive advantage."

STABLE ENVIRONMENTS. According to the China Currency Coalition, a Washington (D.C.)-based organization seeking to end China's manipulation of its currency, the yuan is about 40% undervalued relative to the U.S. dollar.

Frederick Jiang, portfolio manager of the Ivy Pacific Opportunities Fund/A (IPOAX), says he expects Asian currencies -- and equity markets -- of the smaller countries of Southeast Asia to outperform in 2005, notably Singapore, Thailand, Indonesia, and the Philippines. Jiang cited their stable political situations, an expected appreciation in currencies in 2005 following a relatively flat 2004, strong domestic economies, and growing domestic demand.

Jiang's top holding as of Dec. 31, 2004 was the iShares MSCI Taiwan Index Fund (EWT), an ETF that invests in the Taiwanese market. "It's more convenient and quicker to get exposure to Taiwan by investing in an ETF than by purchasing stocks in the Taiwan exchange" he says. Jiang also holds the iShares MSCI South Korea Index Fund (EWY) in his portfolio.

CONCENTRATING RISK. Looking at Asia a whole, Jiang says Asian stocks have an average p-e of only about 12, much lower than stocks of U.S. companies, and an average dividend yield of 3.5%, better than developed markets. "In Asia, values remain cheap, and growth potential exceeds both Europe and the U.S.," he added. Foster adds that "if you are investing in Asia for the long-term, you are investing in the whole package, the companies, their fundamentals, and the local currencies. Forecasting currency movements in isolation [from investing fundamentals] does not mesh well with a long-term investment thesis."

Still, investors should be aware that investing in single-country or single-region ETFs presents risks associated with individual countries and regions. A handful of industries or individual companies tend to dominate the markets of smaller countries. For example, the iShares MSCI Singapore Index Fund (EWS) has 50% of its assets invested in just two sectors, banks and telecom services. Consumer giant Samsung alone accounts for 23.2% of the iShares MSCI South Korea Index.

The table below lists ETFs that invest in Asian markets, and includes those that invest in countries with currencies both pegged and unpegged to the U.S. dollar. Standard & Poor's will continue to track new ETF offerings that are focused on Asia as they are launched.

Exchange-Traded Funds Focused on Asian Equities



Total Net Assets

One-Year Total Return (%)*

Exp. Ratio (%)

iShares MSCI Taiwan Index


$782 million



iShares MSCI South Korea Index


$538 million



iShares MSCI Singapore (Free) Index


$211 million



iShares MSCI Hong Kong Index


$625 million



iShares MSCI Malaysia (Free) Index


$318 million



iShares MSCI Pacific ex-Japan Index


$1 billion



iShares FTSE/Xinhua China 25 Index


$715 million



PowerShares Golden Dragon Halter USX China


$42 million



iShares MSCI Japan Index


$6.5 billion



iShares S&P/TOPIX 150 Index Trust


$95 million



Nasdaq Builders Asia 50 ADR Index


$21 million



*Returns through Jan. 31, 2005 Ghosh is a reporter for Standard & Poor's Fund Advisor

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