SINGAPORE (Reuters): Global investors buying the major Asia stock indexes as proxies for the region’s economic fortunes are getting less bang for their buck as major exporting firms face earnings pressure amid depressed demand.
The indexes that global funds usually buy such as the MSCI Asia ex-Japan index, Japan’s Nikkei 225 and the India’s Sensex, are underperforming those composed of smaller, more domestically focused companies.
“When the large global funds buy Asia, they usually just buy the top 10 stocks in the index, because they’re the largest, most liquid companies,” said Herald van der Linde, head of Asia equity strategy at HSBC in Hong Kong.
Most of these stocks, however, rely more on economic performance overseas than at home, leaving them vulnerable to global risk flare-ups that have knocked their share prices.
Broader indexes and those focused on smaller companies better reflect a country’s economic performance.
The MSCI Asia ex-Japan Small-Cap index, for instance, has slipped 5.4% this year - almost half the main MSCI benchmark’s decline.
Japan’s Topix, which comprises nearly 1,900 companies, has gained 2.8% this year, while the Nikkei 225 of the nation’s largest firms has fallen 0.3%.
India’s Sensex is down 5.6% in 2015, bringing losses for the past year to 2.4%. That compared with a 5.1% decline in the MSCI India Mid-Cap index this year, and a 2.1% gain over the past year.
Pockets of strength
With developed markets’ growth improving and Asia slowing, betting on companies tied to the former may not seem like a bad strategy.
But Asia is still the fastest growing region in the world. The International Monetary Fund forecasts Asia will expand 6.6% this year compared with the pedestrian pace of 2.5% for the U.S. and 1.5% for the euro zone.
And the region has pockets of growth, which domestically focused businesses are exploiting, van der Linde said.
For instance, while China is slowing, retail sales rose 10.8% in August.
Sporting goods retailer Li Ning Co. is benefitting, with shares up 3.7% this year, versus a 9.2% drop in the benchmark CSI300 index.
Only two of the 10 biggest companies on the main regional MSCI benchmark, Tencent and China Mobile, have a significant domestic focus. Four - Samsung Electronics , Taiwan Semiconductor Manufacturing Co., Hon Hai Precision and C. K. Hutchison - are major exporters or have large overseas operations.
In the small cap index, four of the 10 biggest companies are almost entirely domestically focused. The three with the biggest overseas exposure - Hong Kong-listed VTech Holdings and Esprit Holdings, and Singapore-based electronics services provider Venture Corp. - maintain a large local presence.
“The main stock market indices around the globe are generally constructed based on market capitalization, which will not necessarily reflect the proportionate economic footprint,” said Sabrina Callin, global head of equity product management at PIMCO in Newport Beach, California.
But getting to know small companies is often not worthwhile for large funds, HSBC’s van der Linde said, noting that many of them do not meet funds’ liquidity requirements.
Investing even a miniscule proportion of their substantial assets in a small company could also leave these investors with a larger stake than they like.
The price they pay, however, is not getting the benefits of the domestic growth story.
“Merely constructing a portfolio in relation to a specific index is, in our mind, the wrong approach,” said Matthew Vaight, portfolio manager of global emerging markets equity at M&G Investments in London.
“There’s no point in holding shares in a company you don’t like just because it’s in an index.”