Batterymarch overweight in Korea, Thailand and Pakistan

This is part of an AsianInvestor series on the investment outlook of fund managers with Asian portfolios.

Ray Prasad is the Boston-based lead Asia portfolio manager on Batterymarch Financial ManagementÆs emerging markets team, which manages more than $4 billion in emerging Asian equities within both dedicated portfolios and broader mandates. His focus is on the major markets such as China, Korea, India, Hong Kong and Taiwan as well as smaller markets such as Pakistan û essentially all the countries in the MSCI All Country Asia ex-Japan Index.

Batterymarch uses a bottom-up and model-driven investment process, which combines quantitative research with the fundamental work of experienced portfolio managers. The fund house manages around $27 billion in equity assets across all of its products.

What are the biggest opportunities that you see in the markets you are responsible for in the coming 12 months? How are you preparing to take advantage of those opportunities?

Prasad: The biggest opportunities in Asia remain in the domestic consumer space. Urbanisation and industrialisation continue at a fast pace and this is creating millions of new jobs. As a result, purchasing power for goods and services keeps improving. Our models continue to point toward domestic names in Taiwan and Korea and some of the infrastructure and materials-related stocks in China and India. We also selectively like stocks that are exposed to agricultural commodities and banks. We already have exposure to some of these stocks and are looking to increase our weights on pullbacks.

How different or similar is your 12-month investment outlook now compared to the start of this year?

Our outlook really hasnÆt changed. We remain bullish on Asia for the long-term, but cautious in the short run. The recent correction has led to quite attractive valuations for some of the markets and we could see a tradable rally develop. Over the medium-term, Asian countries are grappling with soaring inflation and concerns about slowing global growth, especially in the US. Even with more domestic sources of growth, a lengthy global slowdown could at some point have a significant impact on exports. In addition to that, a reduction in global risk appetite has already caused fund outflows.

From a long-term perspective, however, fundamentals in Asia are still extremely attractive, with better earnings growth than in developed markets and reasonable valuations. Balance sheets also look strong at both the company and sovereign levels. For example, debt-to-equity ratio are less than 50% versus 100% or so for developed countries. You wonÆt find this combination in Europe or the US û growth, value and strong fundamentals. ItÆs a compelling story for longer-term investors.

Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?

The major change at the market level has been additional exposure to Taiwan at the margin because growth prospects there are improving. In terms of sectors, we have pulled back from some resource-oriented names that are beginning to see EPS downgrades or are getting ahead of their fundamentals. We have also reduced our underweight in the financial sector, specifically banks, which have already priced in most of the negatives that worry investors.

What are your favoured markets in Asia?

We are currently overweight in Korea, Thailand and Pakistan, which all have stocks that meet our criteria for investment.

Stocks in Korea have good growth characteristics and very attractive valuations. The market in Thailand is cheap and earnings growth estimates are improving although with the recent political difficulties we are evaluating our positive stance very closely. As for Pakistan, we actually hold only one stock in that market. The Pakistani market is so small that holding a meaningful position in a single security results in an overweight. That single stock, a fertilizer company, is cheap, stable and liquid, and fertilizer prices are going up.

What are the markets you are going to steer clear of in the coming year?

Right now our biggest underweights are in Hong Kong, Singapore, India and Malaysia.

Of these, the Indian market is becoming more attractive post the severe decline in stock prices. This is one market that we are examining closely, taking into account some of the political risk emanating from a possible general election. Malaysia has political issues that will probably worsen and dampen sentiment going forward. Hong Kong, as a financial and services centre, will be under pressure during a global slowdown. Real estate price increases in Hong Kong seem to be stagnating. Singapore is similar to Hong Kong. It is a fairly open economy that will feel a negative impact if the global slowdown continues. We do not think these markets have fully priced in these concerns as yet.

What are your market weightings within an Asia ex-Japan equities portfolio?

We have the following markets weights as of June 30, 2008:

China: 22.3%
Hong Kong: 10.2%
India: 8.3%
Indonesia: 3.2%
Korea: 23.5%
Malaysia: 2.8%
Pakistan: 1.2%
Philippines: 0.9%
Singapore: 4.6%
Sri Lanka: 0.0%
Taiwan: 17.0%
Thailand: 3.5%
Vietnam: 0.0%

Which sectors do you expect to outperform in the coming year?

We continue to favour domestic consumption and infrastructure themes. To that end, we like power equipment and oil infrastructure plays. Coal names also appear attractive, as do some of the Chinese banks and Taiwanese telecom companies. These names have steady and visible growth or other stock catalysts which should hold up in a slow growth environment. With their growth profile, they are attractively valued when compared to stocks in other sectors.

Which sectors do you expect to underperform?

We expect underperformance from some of the diversified financial names such as brokerages, as well as auto and auto component stocks. Export-oriented stocks should also be under pressure as the US and Europe slow down over the next few quarters û these tend to be mostly in the information technology space along with some industrial names.

What are the main challenges that you expect to face in the coming 12 months?

The main challenges stem from the heightened uncertainty in the market. Increasing volatility quite often forces the market to overshoot both on the downside and the upside, and fundamentals might not be rewarded. We are also wary of regulatory risk given how high inflation control is on political agendas.

What are the main risks of investing in Asia at the moment? How are you managing those risks?

We see inflation as the biggest risk to the Asian stock markets on an immediate basis. Rising commodity prices can have a huge impact in these markets because food and energy are a major part of consumer spending there. Unlike countries like Russia, which has plenty of natural resources, Asian markets are commodities importers, not exporters. Think of China and India, with their enormous appetite for oil, steel and other commodities. That puts them at a disadvantage. Looking farther out, a protracted US and global economic slowdown is an even greater potential risk. Asian countries are less insulated from the global economy than other emerging markets because of their trading partnerships, especially with the US.

That said, we believe at this point that Asian markets are likely to have bottomed and might fluctuate around current levels. The markets are just waiting for the US economy to give direction. We are in a transition period right now so we have to be cautious and selective, which is really our approach in any market environment. We focus on individual company fundamentals, and we are finding very good opportunities throughout Asia. Our process also incorporates multiple risk controls û our portfolios are very diversified, and we donÆt take any big bets in terms of stocks, industries or countries. Managing risk is a large part of what we do.