Although the long-term record of the Morningstar Asia Pacific ex Japan Equity funds remains sound, they have recorded double digit declines - 14.4% - since scaling their peak in November last year. In the process, these funds have in aggregate appreciably underperformed their US, UK and European counterpar
ts which have also been falling. This all-round weakness is primarily down to the negativity surrounding the global equity markets and investors' fears that a sinking US economy would drag the rest of the world into a recession. It is also due to factors endogenous to individual countries in the region. For instance, fears are mounting that the Reserve Bank of India will have to resort to further monetary tightening as food and commodity prices-led inflation is showing no signs of abating. This is likely to coincide with softening growth in India, with GDP growth forecast down to 7.5% in the current financial year.
The drag effect of the Asian behemoths on Asia Pacific ex Japan funds becomes evident if one looks at the laggards within the Morningstar Asia Pacific ex Japan Equity category over the last seven months to May. The underperforming - bottom quartile - funds have had more than double the exposure to China compared with the outperforming - top quartile - funds. The same applies to India, wherein the underperforming funds owned more of it compared with their outperforming counterparts. The MSCI China and India indices peaked at the end of October last year and since then are down 27.2% and 19.3% respectively to the end of May, which makes them the two worst performing markets in the Asia Pacific ex Japan region. Funds in the Morningstar China and India equity categories have followed suit, down 25.2% and 19.4% respectively. The extent of this decline is put into perspective if one looks at their returns since March 2003 - when the previous bear market ended - and October 2007, posting a hefty 44.1% and 40.7% annualized return.
It's perhaps this significant underperformance in the short-term and the confidence in the long-term that fund managers in the Asia Pacific ex Japan category have upped their exposure to China and India substantially at the expense of Hong Kong. In fact, current exposure to Indian and Chinese markets is running at historic highs and the move has clearly followed the weakness in these markets over the last seven months.
From an investors' standpoint, the recent downturn in these markets shows that they cannot be viewed in as safe havens from the travails of the world economy. However, this does not mean the two fastest growing economies in the world do not hold long-term potential and diversification benefit. We believe they do and that is why we understand why some fund managers have significantly increased their stakes in the two countries. Nevertheless, we still advocate a measured and guarded exposure to this historically volatile region such that a sharp pull-back in returns does not downright sink an investor's portfolio. We also suggest that investors carefully consider how much direct and indirect exposure they have to China before considering one of the many specialty funds now being offered. Most resources issues, for example, are heavily tied to India and China's continued growth. The price rise in commodities such as oil, iron ore, and copper could just as quickly reverse should demand in the two Asian giants slacken. In any case, we think a broader Asia-Pacific ex Japan fund is a better choice than a narrowly targeted offering insofar as it permits management to use their expertise to favour those markets that offer the best opportunity and allows for greater diversification to help smooth out the bumps.
