For years now, investors taking the Orient Express have had a profitable ride. Of the 82 Asia-Pacific funds followed by Morningstar, the Chicago fund tracker, the typical portfolio in the group is up 37% in the past year. And during the past three years, the category (which doesn't include Japan) has delivered annualized gains of more than 21%. Heavy weightings of China and India stocks have helped drive those stellar returns.
Going forward, however, many experts don't think it will be so easy to make money on Asia shares. China's red-hot economy is losing a little steam -- and in India, it's getting harder to find good stocks at reasonable prices.
VOLATILE REGION. "There was a time when you could buy stocks fairly cheaply, especially in India, but also in China," says J. Mark Mobius, emerging markets guru at the Franklin Templeton fund group. "Not any more."
That's why investors who want to put money to work in these two countries over the long haul (read: at least five years) should stick with a professional money manager who knows the ins and outs of the Asian markets and can ride the volatility endemic to the region. The ideal manager is a pro like Mark Headley of San Francisco-based Matthews Funds, who has spent many years studying Asian corporations and markets -- resorting to hefty doses of tea and melatonin to make it through 20-course dinners with Chinese brokers on just three hours of sleep.
Finding a good fund that invests in China, India -- and in some cases both -- takes some digging. Look at the holdings of most of the funds in the Asia-Pacific (ex-Japan) category, and you'll see that many take a broadly diversified approach, investing in countries throughout the region, including South Korea, Taiwan, Malaysia, and Thailand. However, by buying into these smaller markets, investors are tapping the China market, since the broad Asia funds typically pick companies that benefit from China's growth.
PLAYING IT SAFE. The field is much narrower for investors who want pure plays in either country. For China, there are currently about five open-end funds, as well as a few closed-end funds, to choose from. Since it's still tough, and often unwise, for foreigners to buy stocks directly in the mainland, these funds tend to bulk up on Chinese companies listed in Hong Kong.
At Matthews Funds, which offers seven Asia-related portfolios, Matthews China (MCHFX) focuses on companies tapping the newly fat wallets of Chinese consumers, who are spending by the boatload on everything from houses to cell phones to online gaming.
The $400 million fund's largest holding is China Mobile, the cellular phone company. "It's a growth utility," says Headley, the fund company's peripatetic co-manager. "After five years of falling revenues per user due to competition and price cuts, revenues are starting to improve." Although Headley is "fascinated" by the mainland's Internet companies, "China Mobile is the safest way to tap consumption in China," he says.
ASPIRATIONAL MARKET. Headley and his colleagues are steering clear of most luxury real estate companies. One exception is China Vanke, a condominium developer that caters to the middle class. "They build houses for the factory managers who are seeing wages rise rapidly, rather than the young millionaires who want marble walls," Headley says.
Another fund family with a niche focus on Asia is Guinness Atkinson Funds. Edmund Harriss, who is based in London, has managed the $117 million Guinness China & Hong Kong Fund (ICHKX) since 1994. He also co-manages the Guinness Asia Focus Fund (IASMX), a more diversified portfolio with assets of $34 million. For his China investments, Harriss is avoiding cyclical sectors such as cement, steel, and aluminum, which he thinks have peaked.
Like his rivals at Matthews, he favors consumer-sensitive stocks, such as Hong Kong-based retailer Esprit Holdings. And although auto sales have slowed, he's still bullish on Denway Motors, a longtime holding that produces Hondas in a joint venture with the Japanese company. "There are about 200 million people now in the middle-class bracket," Harris says. "A car is the aspirational item for the young, upwardly mobile Chinese."
STAYING POWER. Templeton's biggest China mutual fund is the China World Fund, with $176 million in assets, managed since 1993 by H. Allan Lam. It boasts a diverse portfolio of holdings, from Hong Kong-based grocery-store chain Dairy Farm International Holdings to Taiwan computer maker Acer. In China, "there are lots of growing companies coming to the market," says Mobius, "but you still need to be very selective."
Among closed-end funds, the Greater China Fund (GCH) is one of the oldest to invest in China: It was introduced in 1992. Wilford Sit, the fund's Hong Kong-based manager at Baring Asset Management, is a big fan of energy stocks, including PetroChina and Hong Kong & China Gas. And he likes transportation companies, such as Cosco Pacific. "Despite all the noise about [diminishing] trade among China, the U.S., and Europe, exports remained very strong for the first half of year," Sit says. "They have not slowed down at all."
Of the diversified funds in the Asia-Pacific group, the real standout is T. Rowe Price New Asia (PRASX). Aside from steady performance, the fund, with a $1.3 billion portfolio of pan-Asian stocks, is a bargain, with an expense ratio of 1.09%, one of the lowest in the category. What also makes this fund especially enticing is the fact that the management team has run the fund for almost a decade. Co-manager Frances Dydasco is based in Singapore and focuses on South Asia and Southeast Asia, while Mark Edwards, based in Hong Kong, covers North Asian markets, including South Korea.
"UNTOLD STORY." The fund is heavily invested in India, though Dydasco recently cashed in some of the fund's most profitable India equities, taking the weighting in that country from 20% to 14%. But for investors who want a diversified fund with some India exposure, this is by far the best option. She has been drawn to industries where there's a large engineering component, including aerospace, automotive, and, to some extent, electronics manufacturing.
"The outlook for manufacturing in India is an untold story," Dydasco says. "India is as competitive on China on cost," Dydasco says. Its companies "are better managed, and they are seeking to add value through research and development and engineering." T. Rowe Price New Asia is currently underweight China. "We believe the economy is going to slow," Dydasco says. "It remains difficult to find good companies in China."
Notwithstanding Dydasco's bullish view, it remains difficult to find mutual funds that concentrate on India. Just one fund -- Eaton Vance Greater India -- focuses on the country, although several others say they are looking at launching India funds. Investors can choose from at least five closed-end funds, including Morgan Stanley Dean Witter's India Investment Fund (IIF) and India Fund Inc. (IFN)
PETROLEUM AND PILLS. Eaton Vance Greater India (ETGIX), managed by Samir Mehta, covers the spectrum in terms of market capitalization, investing in small, midsize, and large-cap companies, including software giant Infosys Technologies (INFY) and HDFC Bank (HDB).
In the health-care sector, Mehta likes the India subsidiary of British healthcare giant GlaxoSmithKline (GSK) Pharmaceuticals. "GlaxoSmithKline has restructured its business, improved margins, sold noncore assets, and now is completely focused on long-term growth in India," Mehta says. Even better, the company has manufacturing and product-related patent protection.
Mehta's favorite stock is Oil & Natural Gas Corp., a state-controlled energy company, which plans to build more than 1,000 gas stations in coming years. "We think it is a long-term growth story because of the growing Indian appetite for oil and gas," he says. The fund continues to own Reliance Industries, India's largest company, with big holdings in petroleum and chemicals. "The underlying value of its assets and cash-generation ability were overshadowed by a family dispute, which has now been resolved," Mehta says.
APPETITE FOR DIPS. Considering that funds focused on India and China have posted spectacular returns as of late, Donald Cassidy, senior research analyst at fundtracker Lipper Analytical Services, advises investors to wait until the next bout of market turmoil to get into some of these portfolios. "The next time something bad happens and the emerging markets have a scare is when I'll go in," Cassidy says.
That's a discipline most investors don't have the stomach to follow. But buying on the dips -- and there are bound to be some in new markets like China and India -- is a strategy likely to pay off for years to come. By Lauren Young in New York, with Assif Shameen in Singapore
EDITED BY Edited by Michael Serrill