Market volatility creates buying opportunity, but minimising risk is key.

This year’s share rout should have value investors asking if it is time to buy large-cap Australian equities on market weakness. Another strategy is buying into the source of the volatility – Asian equities, excluding Japan.

Granted, buying stocks in China, India, Korea, Taiwan or south-east Asia countries will test even hardened contrarians amid growing pessimism towards the region. Further commodity prices falls and a rising Greenback could drive Asian equities even lower.

But the key to successful portfolio investing is finding markets with attractive, sustainable long-term fundamentals and buying high-quality companies that are best placed to benefit, when they trade below their intrinsic or true value.

Trying to pick market inflection or turning points and be a hero rarely works. A better strategy is adding to portfolio during periods of extreme pessimism, such as now, and being prepared to buy more if the market falls from here, to average into positions.

There is no way of knowing what the Chinese sharemarket will do tomorrow, next week or next month. Or predicting the catalyst that loosens the bears’ grips on financial markets and sparks a powerful short-covering rally before the bulls return.

I do know, however, that few investment themes in the next decade will be as powerful as the coming boom in middle-class consumption, most of which Asia will drive. Australian investors must position portfolios to capitalise on what will be on the great trends of our time.

As I have written before for The Bull, an expected increase in middle-class consumers from 1.9 billion in 2009 to 4.8 billion by 2030 on OECD forecasts has profound implications for the global economy and financial markets. Look at the recent success of Blackmores and other western companies selling to Asian consumer markets. 

Asian equities, in aggregate terms, look historically cheap. The price-to-book ratio for the MSCI Asia (ex-Japan) index is about 1.1 – a figure it has only reached on four occasions, including the Asian and global financial crises.

Yes, care is needed with the price-to-book ratio. As evident after the 2008-09 Global Financial Crisis, book values can be inflated if companies and banks have not sufficiently impaired assets or non-performing loans. But Asian equities have historically produced strong gains over the next few years when the price-to-book ratio gets to these levels. 

Price Earnings (PE) multiples, less useful for frontier markets, also suggest better value. Hong Kong’s Hang Seng Index, for example, trades on forward PE of 10, its lowest in years. Investors seeking exposure to Chinese companies, on a more reliable exchange, could consider a managed fund that invests in Hong Kong.

Other signs suggest value is emerging in Asian equities. Indiscriminate selling has crunched commodity companies, banks and even consumer-focussed stocks in Asia. Buying during periods when everything is being dumped is invariably the most rewarding. More takeovers and management buyouts in the region suggest the smart money sees value.

That’s not to say Asian equities will not fall further, that higher volatility will quickly subside, or that economic risks will recede. Those who buy now must be prepared for at least another quarter or two of big swings and accept consistently higher risks in these markets.

But the time is right to start lifting a small part of portfolio allocations to Asian equities, gradually over the next six months rather than in one go. This is the opportunity to focus long-term portfolios toward an Asian consumption theme that shows no signs of slowing, based on recent Chinese data. At lower prices. 

Strategies to benefit

Consider a three-pronged strategy when adding Asian equities exposure to portfolios. First, use an Australian-based managed fund rather than buying Asian equities directly, to improve diversification. 

Second, stick with active managers rather than exchange traded funds. ETFs have their place, but in volatile markets it pays to have professional investors watching your back rather than products, such as ETFs, that replicate an index and the market loss. 

Third, look for ways to improve the risk/reward equation. Listed Investment Companies over Asian equities (ex Japan) an example. At 87.5 cents, the PM Capital Asian Opportunities Fund, which I have identified previously for The Bull, is trading at a signficiant discount to its latest pre-tax $1.07 asset backing. 

PM Capital Asian Opportunities Fund


Source: The Bull

The Asian Masters Fund at $1.27, trades below its latest pre-tax net tangible assets (NTA) of $1.34 a share. 

Asian Masters Fund


Source: The Bull

Platinum Asia Investments, at 93 cents a share, trades at its pre-tax NTA of 93 cents. A manager of Platinum’s standing usually trades at a premium to NTA. At 86 cents, another LIC newcomer, Ellerston Asian Investments, trades below pre-tax NTA of 97 cents.

Options issuance, assuming options are converted, can in theory reduce discounts to NTA and some investors argue that post-tax, not pre-tax NTA, should be used for compaisions. Also, the downturn in Asian equities this year is rapidly driving asset prices lower, so the market is correctly looking forward and adjusting through lower LIC prices. 

Even so, several Asian equities (ex-Japan) LICs, from highly regarded managers, are trading well below their NTA – possibly too far. Terrible sentiment towards Asian equities has crunched their shares price this year. 

Value investors will recognise an opportunity to gain exposure to Asian equities at a discount during market turmoil, using diversified ASX listed investment companies that trade at an unreasonably large discount to their underlying value – a double-discount of sorts for true believers in the long-term Asian consumption theme, and a method to further reduce valuation risk.

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week’s newsletter


Tony Featherstone is a former managing editor of BRW and Shares magazines. He is not a licensed financial adviser. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at Jan 21, 2016.