UNSW Business School/ Banking and Finance

FINS2622 Session 2 2017

Investment in Asia Pacific Markets I

General issues .
References

These books available as e-book at library.unsw.edu.au

Mark Mobius
Chapters: 4, 5, 6, 7, 8, 9, 10
Gordian Gaeta
Chapters: 4, 7, 8
I Preliminaries: Macro Issues

Criteria that may be used to select which countries to invest

in
I.1 Investment Instruments
EM Mutual Funds: Close- End/Open- End
Closed End: trade as a listed company on a stock
exchange
Capital raised by issuing a fixed number of shares (IPO).
Investors cant ask to redeem from manager; they must
sell on the market.
NAV (net asset value) is calculated daily: total value of all
the companies held in the portfolio, including cash and
less liabilities / number of outstanding fund shares.
As these fund shares are traded it so happens that the
price of each share may not correspond to the NAV.
Range of discount and premium may be wide. More sell
at discount but when they first issued they sell at a
premium. Another puzzle.
Domestic Listings of EM Companies in EM Stock Markets
Depository Certificate Listings of EM Companies in
developed stock markets

ETF similar to closed end funds- tracking an index such

as MSCI Emerging Markets Index trade on stock
exchange like a stock
I.2 Investment styles

Value vs growth ?
Short vs Long term?
Buy or Sell ?
Timing of buying/selling?
Why a crisis may be a best time to buy?

Importance of being contrary: dont follow the crowd

Herding behaviour/Contrarian Strategy/Superstition
Momentum Strategy
I. 3 Risk Factors (examined in various forms
under Karolyi risk factors)
Risk: Why not to fear it.
Forms of Risk: General
Political/Currency/Company/Broker/Settlement/Custodial/O
perational (inadequate auditing and bookkeeping
standards)/Market
Measurements?

The rule of law: contracts, property, justice/corruption

Regulatory effectiveness: licenses, ownership, taxes

A
Economic openness: trade, investment, capital flows
Attempts to put numbers to these considerations: the
higher the better
See Fig. 41, GG, p. 90 (scale from 0 to 100)
and Karolyi, Fig. 6.1, p. 104 (scale -1.5 to 1.0)
Ranking:
North America
Europe
Asia Pacific &South/Central America; Middle east/North
Africa roughly the same
Sub-Saharan Africa
 Economic Freedom 2012 from 0 to 100 (best). Gaeta page 90

North America Europe Asia Pacific

Open Markets 73.6 73.0 50.0

Regulatory Efficiency 81.1 72.4 68.0

Limited Government 66.1 53.95 73.1

Rule of Law 69.35 58.4 37.4

Global Competitiveness
Ranking by World Economic Forum: out of 144 countries in
2014
Singapore (2)
HK (7)
Japan (9)
Malaysia (24)
Korea (25)
Whole report:
http://www3.weforum.org/docs/WEF_GlobalCompetitivenes
sReport_2014-15.pdf
Global Competitiveness (continued)

China (29)
Thailand (37)
Indonesia (38)
The Philippines (59)
India (60)
Vietnam (70)
Laos (81)
Cambodia (88)
Myanmar (139)
Variables used in constructing global
competitiveness
Based on 12 pillars of competitiveness
Institutions, Infrastructure, macroeconomic development,
health and primary education, higher education and
training, goods market efficiency, labour market
efficiency, financial market development, technological
readiness, market size, business sophistication,
innovation (R&D, intellectual property)
Governance Indicators (World Bank): aggregation of
See attached Excel file
6 dimensions of governance
Voice and accountability
Political stability and absence of violence/terrorism
Government effectiveness
Regulatory quality
Rule of law
Control of corruption
http://info.worldbank.org/governance/wgi/index.aspx#home
Note a positive relationship between higher governance
levels and growth (size) of the stock market.
Also refer to Karolyi Chapter 7 on corporate opacity.
Global Manufacturing Competitiveness
(The Global Manufacturing Competitiveness, US Council
on Competitiveness)
Ranking
China (1), India (2), Korea (3), US (4), Germany (8),
Singapore (9), Thailand (12), Australia (15),
Note: demise of Australian automotive industry and
manufacturing industry (?)
Investing in Asia Pacific markets: Is it a
fundamental/long-term investment or a temporary
shift?
Developed economies are in slow recovery:
Key issues in developed economies: public debt rising and
slow growth
Since the final crisis developed economies depend more
and more on emerging markets to emerge from the
present stagnation. On the other hand Asia Pacific
economies are improving fast in many fronts.
Answer: yes its a fundamental shift and a long term
prospect for investments in Asia Pacific markets.
Chinas current market conditions

Issues:

Devaluation: assessment?
Growth targets: 7% achievable?
Structural adjustment: more services less manufacturing?
Anti corruption drive?
Impacts on Australia: FTA?
Other issues?
I.4 Consider frontier markets, GG Chapter 8

What are they in Asia Pacific region? Vietnam, Laos,

Cambodia, Myanma
Favourable indicators:
Faster growth
Favourable demographics
Strong macroeconomic fundamentals (lower debt level
44% of GDP in contrast to 73% of GDP of developed
economies)
Integration with global economy
Attractive market valuations
Inefficient markets
Low correlation to other markets
II Valuation: micro issues

A. CAPM: Early Theory and Some Estimates

E(Ri) = Rf + Beta (i)* [E(Rm) Rf]
This model is for one economy/market
Adapted it for International CAPM
Two steps:
1.Country betas in Asia Pacific countries
Re-interpret Rf and Rm
Can also use the risk premium as circulated before.
2. Betas of investment projects being considered for Asia
Pacific countries
Examples of country betas from US perspective:
From 1991 - 1996
Philippines (1.99)
India (1.86)
Thailand (1.91)
Indonesia (1.68)
Korea (1.58)
Malaysia (1.47)
From 1970 - 2006
Hong Kong (0.84)
Singapore (0.92)
Australia (0.77)
USA (1)
Note difference in periods and techniques of beta
estimation including the pitfalls of estimation.
How to convert to Australia being the home country, namely
Australia beta = 1?
Project beta for an investment being considered for an Asia
Pacific country e.g. China:
Choose a proxy beta from a listed company in China
B. CAPM: Recent theories and estimates
Foundation work of Sharpe and Lintner: CAPM as above.
Difficulties in application to international finance: Requiring
perfect capital market, which means markets are
perfectly integrated
Then with capital market integration we get a a world
version of CAPM
Some success in being applied to developed market
returns but not so to emerging markets.
Lack of integration is a major reason. Research heading to
gradual integration as a way to overcome lack of
integration. That is, integration is a time varying process.
Some limited success.
Some generalizations as a result:
Volatility in emerging markets is high but correlations with
the world are low or even negative.
Hence adding emerging markets may lead to a well-
diversified portfolio with reduced portfolio volatility. Recall
portfolio variance = sum of individual variances +
covariances.
A plausible explanation of lowered volatility: with financial
integration emerging markets are closely watched by
analysts. The case of increasing informational efficiency.

Recent variants of CAPM: moving away from traditional

one factor and adding more factors. Obviously the
market factor is incapable of capturing all risk as was
assumed previously. Hence:
Fam-French 3-factor model: size of company, book price to
market price of share ratio (B/M), and market factor
4th factor added: momentum
5th factor: liquidity
Asian markets: evidence of effects of liquidity and size
Cost of equity estimates based on size and liquidity CAPM:
Cost of equity estimates based on size and liquidity CAPM
2009

Country Cost of equity estimates

%
Australia 18.92
New Zealand 15.40
Indonesia 29.21
Singapore 26.45
Malaysia 16.33
Thailand 24.31
Hong Kong 23.77
China Shenzen 25.96
China Shanghai 25.38
Philippines 27.03
Japan 11.91
South Korean 23.76