Turkish security forces have recently arrested almost 50 people as a result of revelations about an alleged plan, codenamed “Sledgehammer”, for a coup against the ruling AK party in 2003. Amongst those detained were the former heads of the Navy and Air Force, 15 ex-Generals and 32 incumbent officers. Last year another sweep rounded up over 200 people, including military personnel, lawyers, journalists and politicians in the Ergenekon conspiracy, also aimed against the AKP. The prominence of the people arrested and the scale of the operations reveals just how hard the fight between the secularists (who regard themselves as the preservers of the “legacy of Ataturk”) and the more populist and Islamic leaning ruling power is.

The Armed Forces in Turkey have long been regarded by both Turkey’s NATO allies and by the “man-in-the-street” as a much safer pair of hands than politicians, and especially Islamic-leaning politicians. This time around the previously all-powerful military machine has not felt able to stop the investigations and arrests. The current Chief of Staff, Ilker Basbug, said in a recent interview: "Turkey has definitely lived through certain events since the 1960s; however, we tend to view these as passé. We believe our citizens need peace and quiet. Political power changes hands through elections, through democratic means". This sort of comment illustrates the shift in power away from the military; a coup is a remote possibility now and the military are slowly and painfully coming to terms with the fact that they no longer have veto power over the Government in Turkey. 

This does not however, mark the end of the fight between the secularists and the Government. The battleground is now the courts, where another attempt to ban the AKP is possible. Even if this does not happen, the AKP may well try to change the Constitution to reduce the power of non-military secularists. Either way, the message is the same: the fight between secularists and Islam in Turkey is nasty, and getting nastier, but is still – just – civilised and controlled. 

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

Following a reasonably positive start to the year, equity markets saw some profit taking to finish January lower. The MSCI Emerging Market index fell 5.6% vs. a 4.4% fall for AC World. Equities were hurt by concerns about Chinese monetary tightening, US banks over-regulation and by the increased risk of Greek debt default. Macro drivers turned negative: commodity prices were down 6% (as per the CRB Jefferies Commodity Index), oil prices fell 7%, EMBI spreads rose 30bp and the USD was up 2% (as per the DXY Dollar Index).

Albeit a difficult month for emerging markets, January followed six successive months of positive returns. The asset class is up 126% (as at January 31st) from the November 2008 low.

From a country basis, Brazil, a key exporter of commodities to China, was the worst performing market falling by 11% in dollar terms abetted by the 8% decline in the Brazilian real. Key drivers were Chinese monetary tightening and lower commodity prices. By the same token, Peru fell also by 10%. In Asia, Chinese policy announcements related to a stricter monetary policy dragged the Chinese equity market 8.6% lower.

EMEA was the best performing region for the second consecutive month, falling just 0.7%. Despite the decline in oil prices, Russia ended the month higher, buoyed by gains in the materials and financials sectors. The defensive market of Israel also posted slight gains. Turkey also performed well, up 2.4% on renewed hopes of a deal with the IMF and on cheap valuations.

With an increase in risk aversion, out-performing sectors in January were healthcare (-0.3%) and utilities (-1.3%).  Consumer discretionary (-8.6%) and materials (-6.9%) underperformed.

Market outlook

Now that all the world’s major economies are out of recession, the focus has shifted to the upturn and how strong it might be. Recent evidence of indifferent growth in the developed world and signs that China might be about to slow the pace of future expansion, caused concerns that the upturn - and as a possible consequence company profits - might be less strong than hoped in the upcoming years. These doubts are reasonable, but we should bear in mind that in months following changes of economic trend there is often changeable and sometimes conflicting data and that it will be some time before the real shape of the uptrend is clear. This background will keep equity markets volatile at times.

We continue to believe that the recovery of the global economy is ongoing, but we think that the acceleration phase, which was based on easy financial conditions, is over. In addition, the recovery will continue to proceed at different speeds in the various regions. We expect developed economies to grow at a subdued and below trend pace during the next couple of years. On the other hand emerging economies will grow at a much stronger pace driven by the BRIC countries. To talk numbers, the IMF in its latest projections (26th of January 2010) expects emerging economies to growth at 6.1% in 2010 and accelerate to 6.3% in 2011. While developed economies are expected to grow at 2.0% in 2010 and 2.4% in 2011.

We believe that the biggest risk to developed markets relates to managing their current account deficits and large balance sheets. Given the ample output gap, inflation will not be a problem in 2010 for developed countries. On the other hand, managing growth and inflation will be the biggest task for emerging economies. If emerging economies succeed in maintaining growth with limited inflation, we expect to see a further re-rating of the asset class given the higher growth rates relative to developed markets.

As far as financial markets, we expect them to be more balanced as financial conditions have improved since 2008/09. As it does, the broad market-directional themes that have been driving the markets in 2009 will likely need to be replaced by, above all, an emphasis on relative value and asset selection – in other words, to rely a little less on beta and focus on alpha.

Strategy

The strategy is overweight Russia, Mexico, Turkey and Thailand funded by under weights in Brazil, China and South Africa.

The strategy is overweight the materials and consumer discretionary sectors. We are underweight consumer staples and the energy sectors.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class. This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

MSCI Asia ex Japan fell by 6.04% in USD in January 2010. Equities were hurt by Chinese policy tightening, the increased risk of Greek debt default and the announcement on US bank regulation. Because of this, various macro drivers were unhelpful such as falling metal and oil prices and rising EMBI spreads, and the rising USD affecting the carry trade. Asian earnings were still being upgraded, but this wasn’t enough to prevent investors reducing their exposure to risky assets including Asian equities.

In Asia, Chinese policy announcements dragged the Chinese equity market lower by 8% with Chinese financials being hard hit, but financials across Asia also dragged down the Korean, Taiwanese and Indian markets. Indonesia was the only market to rise (+2.02%). With increased risk aversion and a spike in the VIX, defensive sectors such as healthcare, telecoms and utilities performed best, while consumer discretionary and financials were adversely impacted by rising inflation and tightening expectations.

Chinese macro figures were scrutinised for signs of overheating while the western world worried about growth (and China). Chinese CPI rose 1.9% y/y in December, the trade surplus was USD18.4bn as imports rose 55.9% y/y and exports rose 17.7% y/y both in December. Retail sales and industrial production rose 17.5% and 18.5% respectively, while GDP (y/y) for Q4 2009 grew 10.7% (source: Bank of America Merrill Lynch/1st Feb Asian Monthly).

Market outlook

Now that all the world’s major economies are out of recession, the focus has shifted to the upturn and how strong it might be. Recent evidence of indifferent growth in the developed world and signs that China might be about to slow the pace of future expansion caused concerns that the upturn - and as a possible consequence company profits - might be less strong than hoped in the upcoming years. These doubts are reasonable, but we should bear in mind that in months following changes of economic trend there is often changeable and sometimes conflicting data and that it will be some time before the real shape of the uptrend is clear. This background will keep equity markets volatile at times.

We continue to believe that the recovery of the global economy is ongoing, but we think that the acceleration phase, which was based on easy financial conditions, is over. In addition, the recovery will continue to proceed at different speeds in the various regions. We expect developed economies to grow at a subdued and below trend pace during the next couple of years. On the other hand, emerging economies will grow at a much stronger pace driven by the BRIC countries. To talk numbers, the IMF in its latest projections (26th of January 2010) expects emerging economies to grow at 6.1% in 2010 and accelerate to 6.3% in 2011. While developed economies are expected to grow at 2.0% in 2010 and 2.4% in 2011.

We believe that the biggest risk to developed markets relates to managing their current account deficits and large balance sheets. Given the ample output gap, inflation will not be a problem in 2010 for developed countries. On the other hand, managing growth and inflation will be the biggest task for emerging economies. If emerging economies succeed in maintaining growth with limited inflation, we expect to see a further re-rating of the asset class given the higher growth rates relative to developed markets.

As far as financial markets, we expect them to be more balanced as financial conditions have improved since 2008/09. As it does, the broad market-directional themes that have been driving the markets in 2009 will likely need to be replaced by, above all, an emphasis on relative value and asset selection – in other words, to rely a little less on beta and focus on alpha.

Strategy

The strategy is overweight Korea, China and Thailand funded by under weights in Hong Kong, Taiwan and Malaysia.

The strategy is overweight the materials, technology (ex software) and real estate sectors. We are underweight energy, consumer staples and telecom sectors.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class. This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Author: KR Min, Senior Research Analyst

Who is the Kumho-Asiana Group?

Kumho-Asiana (“the Group”) started in 1946 by establishing a small company called “Kwangju Taxi” based on two second hand American taxies. The company followed the name of the city in the south western (Honam) province of Korea and ever since has been a representative from the south western province in the Korean business society. They have expanded their business area via either new start-ups or acquisition; Kumho Express, 1948, Kumho Industrial/Tire, 1960, Kumho Petrochem, 1970, Asiana Airlines, 1988, Daewoo E&C, 2006 and Korea Express, 2008 (the current Kumho Tire was actually spun off from Kumho Ind in June 2003). The honorary Chairman, Mr. Park, Sam-Gu, is the son of the founder of the Group.

Kumho-Asiana Group structure

Source: BofA Merrill Lynch

The Group consisted of four business areas – chemical/tire, airlines/logistics, construction and financial -with 21 companies, some of which are about to leave the Group, though.

Starting from two taxies 64 years ago, the consolidated shareholders funds increased up to KRW1.8tn (consolidated asset of KRW10.2tn) at 2008 end. Consolidated P/L in 2008 showed sales of KRW7.2tn, EBIT W400bn and net loss of W166bn due to a high gearing ratio. The net interest-bearing debt ratio was 360% with gross debt W6.6tn and cash W204bn (gross debt amount didn’t include contingent liabilities of “put option” at the time of Daewoo E&C acquisition).

The old Ford – the same model as the first two taxies

Source: www.naver.com

Given that the Group is the de-facto business representative in Honam Province, workout or restructuring of the businesses (or let-go of some businesses) may have negative political implications as well, apart from economic reasoning. The Group was ranked at 8^th out of Korean Chaebols in terms of assets, but certainly not any more, going forward.

What were the problems?

Acquisition of Daewoo E&C

It was December 2006 when the Group closed the deal to acquire a 72.1% stake in Daewoo E&C from KAMCO (Korea Asset Management Corporation – a Government agency for collecting non-performing loans), spending W6.5tn. There were other local bidders – Doosan Group (bidding price of c. W5.5tn for 50%+1 share, not 72%), Prime Group (c. W6tn), and Eugene Group (c. W6tn), who were all regarded lucky not to have been chosen. However, most of the bidders suffered quite a lot during the global downturn in ’08-‘09.

Daewoo E&C under Kumho-Asiana

Source: Yonhap News Agency

Funding structure

The Group paid total of W2.9tn and the remaining of W3.5tn funding was from investments by FIs (Financial Investors) as shown below. However, a significant portion of the money paid by the major four companies of the Group – Industrial, Tire, Petrochem and Asiana – was raised by increasing leverage. Combined net debt of four companies at 2005 end was c. W4.1tn, but it went up to c. W6.6tn at the end of 2006 after the acquisition, increasing the gearing ratio sharply from 110% in ’05 to 171% in ’06.

Change of combined gearing ratios of Industrial, Tire, Petrochem and Asiana (Before vs. After)

Source: CLSA

The increased portion of net debt has mostly come from higher leverage through more bank lending and issuance of corporate bonds. Furthermore, the Group has additional liabilities regarding the FIs.

Investment Structure in Daewoo E&C

Source: CLSA

Some of the investors - securities companies and private equity funds - have already exited via issuing ABS.

Terms and conditions with FIs

Payment Guarantee: W3.5tn invested principal by FIs were guaranteed by the Group at a 9% annual interest rate with 3 year maturity. Or…

Put back option: if the share price of Daewoo E&C is under W32,500/share (=the equivalent stock price for guaranteeing 9% yield per annum) at maturity, the Group has to purchase the shares from the FIs at the market price. The shortfall amount at the end of 2009 seemed to be c. KRW2tn (=40% stake x price difference of [W32.5K/share – W18K/share]) and c. W4.2tn including the original investment by FIs due by June 2010.  

Increased indebtedness and a contingent liabilities burden have made the Group more worse off during the global downturn. Severe restructuring and a re-sale of Daewoo E&C are essential for survival.

Acquisition of Korea Express

After having acquired Daewoo E&C, the Group also purchased a 60% stake in “Korea Express” for W4.1tn in March 2008 - No 1 logistics company in Korea that had been under court protection since June 2001: another legacy of the financial crisis of a decade ago. Korea Express is 50% owned by the Group (including Asiana 24% and Daewoo E&C 24%) and the remaining 10% is owned by other small investors. Had it not been for the workout process, the Group might have tapped the market for selling Korea Express as well.  The chance is still open… in theory.

Counter examples – lesson from other Chaebol

Here are some (counter) examples that managed to avoid Kumho-Asiana’s fate during global crisis.

Hanwha Group was the preferred bidder for the acquisition of DSME (Daewoo Shipbuilding & Marine Engineering) in 2008. However, affected by global financial recession, Hanwha Group failed to persuade financial investors to join the bid as well as failing to raise finance by themselves via selling their assets. The security deposit of c. W300bn paid to KDB (Korea Development Bank) and KAMCO for the acquisition is now in dispute between the sellers and the preferred bidder. When Hanwha submitted the bid, market capitalization of DSME was c. W7tn in the summer of 2008, but it came down to W2.7tn at the end of 2009. Given that Hanwha intended to acquire a 50%+ stake at DSME, they could have saved, in theory, c. W2tn without considering the management premium but despite this, they wasted W300bn cash for not taking the deal.

A similar story can be found in Dongkuk Steel Mill (DSM)’s attempt to acquire Ssang Yong E&C (a construction arm of old Ssang Young Group before Korean financial crisis a decade ago). The first attempt to sell Ssang Young E&C by creditors began in June 2007 and it took c. 1.5 years to see the deal nullified. DSM was willing to pay c. W460bn (they would pay KRW31K per share, including management premium) but the share price collapsed to c. KRW6K (1/5 of the original deal amount) when they abandoned their right to purchase the company. The associated cost was KRW24bn for the key money and it is the subject of a legal dispute as well. 

Nobody would know what would have happened if the two deals have been signed. However, assuming the similar deal structure like Kumho-Asiana, two cases might have followed the similar paths that Kumho-Asiana took.

Restructuring of Kumho-Asiana Group

The restructuring process will begin by combining a workout program, self restructuring and sale of assets/affiliate. The largest shareholder, Park family, will have to surrender their stakes in Petrochem (46.9%) and Industrial (8.2%) to the creditors as collateral for successful implementation of the restructuring effort.

Red light on Kumho-Asiana

Source: Yonhap News Agency

Work out

The two most heavily geared companies (Industrial and Tires) started their workout program led by creditors effective from January 6, 2010. Creditors will have due diligence for two months to draw the detailed map for the workout program and to set the terms and conditions for the workouts with the Group in April. Re-scheduling of debt profiles, haircuts, provision of new loans, debt-equity swaps, lay offs etc. will be discussed. In the mean time, all standstill of existing debt will be effective for three months (by March 30 for Industrial and by April 16 for Tires).

Self restructuring – lay offs …etc

The business environment for Petrochem and Asiana look to have bottomed out from the global downturn in 2009 and especially, backed by strength of KRW and pent-up demand on outbound traveling, Asiana have been in the way of sharp improvement. However, two companies have to put themselves into self restructuring programs to reduce their gearing ratios and to pay contingent liabilities.

20% lay offs and 20% salary cut of the management, mandatory monthly vacation without being paid for the employees, reduction of benefits, lay offs etc. are the typical menu under self-restructuring.

Re-sales of Daewoo E&C to KDB

For the last couple of months the Group has tried to sell the stake at Daewoo E&C to anybody showing interest but failed. KDB is the only counter party who can purchase the shares, locking loss and providing fresh money to the Group. KDB is to purchase a “50%+1 share” to control the management right for future re-sale via a private equity structure with other financial investors. Therefore, the original FIs for Daewoo E&C who are demanding KDB’s purchase at the price of W35K/share have to admit whatever negative condition provided by KDB. It is expected that KDB’s offer price would be close to W18K/share (40% premium to the current price of W12.5K/share, but 50% discount to the guaranteed price).

Sales of Kumho Life

KDB will set up a separate PEF (private equity fund) to purchase Kumho Life shares as a method of providing fresh money into the Group. NPS (National Pension Service) will be a major investor for the PEF, willing to pour up to W260bn for the deal, followed by Consus Asset Management Company, one of whose major shareholders is Kumho Life (!). Korean Re wants to be an investor for the PEF, with allegedly hoping for a life insurer in the long run.

Asset sales

The estimated proceeds amount from sales of assets owned by four companies will be up to W1.3tn, according to the Group, but it will take time to monetize them. One of the recent news flow is that the preferred bidder for purchasing the “Seoul Express Bus Terminal” from Industrial made a failure in settling the deal; no payment of W270bn to Industrial. Industrial should start the entire process from the beginning again.

When the Group was announcing restructuring plan with KDB

Source: Money Today

Troubleshooting

Financial investors into Daewoo E&C were not happy to accept the workout program initiated by KDB and want to set their own voice to restructure Industrial, Daewoo and other affiliates. They don’t accept KDB’s plan of a debt-equity swap into Industrial shares; the shortfall amount between the guaranteed price and KDB’s offer price should be swapped into Industrial’s shares. FIs are concerned about the accrued interest amount – basically they don’t want to give up what they were guaranteed by the Group.  

The family of the Group are supposed to surrender their private assets as collateral to fulfill the entire restructuring but it’s not going smoothly yet.

KDB should coordinate all this troubleshooting, but it will definitely take time to make many participants less disappointed. Time is critical to restructuring, but… due diligence will take 2-3months for drawing the big picture and actual implementation of workout and restructuring will be from early/mid of 2Q10. Successful recoveries will be also related to the recovery of global economy, especially Petrochem and Asiana.

Impact to the market

The possible struggling of the Group has been widely expected in the market during the last couple of months and the actual impact to financial markets was not big enough so far. Relatively speaking, Kumho was rather small in terms of indebtedness compared with Daewoo’s trouble in early 2000: Daewoo’s total financial liabilities were W80tn vs. W18tn for Kumho.

The other reason for a relatively smaller impact is that it broke out in the time of recovery from the global recession – especially since Korea has been recovering very fast – and it does have minimal impact to the economic system. Various experiences on workouts and restructurings since the Asian financial crisis are working effectively for the creditors to make their own decision rather quickly.

Korean regulators want to cut the spread-out of negative impact throughout the economic system, confining losses to the creditors and financial investors as well as the employees of the Group. So far, it has been working.

Nonetheless, banks are bleeding somewhat…

Banks’ exposure to Kumho-Asiana Group

Source: CLSA

According to CLSA’s forecast, the assumption of 20%-50% write-down for the loan made to Industrial and Tires and 7%-20% write-down to Petrochem and Asiana would require the total provision amount of W420bn-W1.1tn to the banking sector, apart from the loss with respect to the investment into Daewoo E&C. Macquarie Securities estimated the possible provision form the loans would be W620bn (assuming 25% write-down), which is c. 5% of 2010E aggregate earnings. Merrill Lynch is estimating a similar impact to the balance sheets of banks in 4Q09: W600-W700bn provisioning burden.

Depending upon the reset of the workout and restructuring, the long term impact wouldn’t be as bad as initially feared.

Closing

It didn’t take a long time to collapse the entire structure of the Group, putting back the shape of the Group before the acquisition of Daewoo E&C – actually it went further backward because the largest shareholder (Park’s family) had to put up their shares of Petrochem (de-facto the Holding company) and Asiana Airlines as collateral. Once the restructuring doesn’t go smoothly as planned, the Park’s family may lose the significant portion of the management control over the Group, in theory. One of the threatening examples is the suggestion by FIs exposed to Daewoo E&C to further invest into Industrial, aiming at controlling the most of the Group.

The Group’s complete recovery from the workout and restructuring programs looks quite distant at this point, given that the creditors just started to conduct due diligence for setting up road maps for the main four companies. Obviously, actual recoveries of each company are dependent upon how fast the global economy is stabilised. In fact, outbound travel demand and cargo demand are working favourably to Asiana business. Kumho Petrochem’s business environment won’t be looking deteriorated going forward; in fact they will benefit from increasing demand on chemical products. However, the business sentiments for tire and construction are far from looking good at the current stage.

In some sense, it would be lucky to get much support by KDB and other financial creditors to draw a common conclusion in a short period of time and to cut any spill-over impact to other economic sectors. When do they come back? It’s too early to forecast any time horizon, even if all four companies are properly restructured quickly. At least, for the time being, it will be difficult to fulfill the Group management’s philosophy of “contribution to country and society” and the goal “to become industry leaders in creating value”, given that they have to let many employees leave the Group earlier and to shrink their business.

The management was so blind that they couldn’t see the risks behind the stretched acquisition or expansion. They seemed to be too greedy to detect and control the entire risks associated with business development. Too much greed combined with significant leverage does bring lots of cost that should be born by not only the management, but also by all related parties, including employees as well as lenders and shareholders.  

Kumho-Asiana Group’s failure to take off will provide a good lesson along the development of Korean corporations.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

China has been focused upon as an exciting destination with attractive growth potential - especially when considering the urbanization story and consumption from the large population. On the other hand, Korea has been viewed less so, it’s image of being a saturated market is perceived as offering little growth potential. 

However, I would like to remind you that Korea is actually a leveraged market to China’s growth. There are more specific stock names in this theme (some notable names are mentioned later in this article), but to begin with, total export data suggests that Korea as a whole could be considered an indirect China play (exports include final product, but also intermediate goods to be reprocessed in China which will in turn be re exported to other destinations). In addition, from China’s import perspective, Korea is placed as the second largest country of origin with the first being Japan.  

Given that many Korean companies (including major corporates like Samsung Electronics and Hyundai Motor) have China manufacturing subsidiaries, Korea’s exposure to the China market is, in fact, bigger than what one may first think. 

I believe that it is the right time to look at the Korean market again from this angle.

Laid out below are more details on Korea’s exports and China’s imports, and some brief explanations on individual companies’ exposure to the China market.

Trading partner

Korea’s 2009 (full year) exports were down 13.9% to $363.5bn from $422.0bn in 2008.

A decline in exports to China was less, down 5.1% in 2009, and China has remained the biggest export market for Korea accounting for 23.9% of total exports in 2009, rising from 21.7% in 2008. EU took up 12.8% followed by ASEAN 11.3%, US 10.4% and Japan 6.0%.  

Korea Export by major region

FOB based, Source: Ministry of Knowledge Economy (MKE) and Korea International Trade Association (kita.net)

More specifically, Korea’s 13 main export products are detailed below (The Ministry of Knowledge Economy summarises monthly data for these 13 products in their press release).

Korea Export by 13 main products

Source: MKE and Korea International Trade Association (kita.net)

China has been the number one destination for most major products, especially for LCD devices and petrochemicals. For 2009 in particular, China’s IT subsidy plan for rural areas has helped support a significant increase in Korea’s LCD device exports. As you can see below, LG Display has a large market share within local LCD TV set makers. Also for petrochemical, China’s overall stimulus package boosted the demand (China’s supply coming in but still not at full self sufficiency rates), so Korean petrochemical benefited and was also helped by KRW weakness and close location to China. 

China imports by main region

CIF Based, Source: CEIC, BoAML

Looking at China import data, Korea is the fourth biggest region and the second biggest partner as a single country, accounting for 10.2% in 2009. The Korean portion has been relatively stable. Japan remains in the number one position, though falling.

(Korea export to China and Korea numbers within China import are different and I believe the reason is that export is booked in FOB terms, while import in CIF terms).

Corporate exposure

Some notable companies are presented below.

IT

Samsung Electronics (SEC) – One of the world’s biggest electronics companies which also has a significant position in China. 16% of 2008 consolidated revenues came from China. From the market data available, SEC’s LCD TV market share in China was 4.5% in 3Q09 (LCD TV market share source: Display Search, CLSA), the number 7 position following the top 6 local makers. Handset market share in China was 18.5% as at 3Q09 (handset market share source: Strategy Analytics, CLSA), the second largest following Nokia’s 37.4%.

LG Display – c. 55% of LG Display’s consolidated revenues are generated from TV panels and within this 55%, 15% is from the China market. The China LCD TV market is dominated by local set makers and LG display’s market share within major local TV players is relatively high. LG Display has nearly 40% market share (source: Mirae Asset Securities) in Skyworth, the number 1 set maker with a 19.4% market share in 3Q09.  For other local set makers like Hisense (15.7% market share, number 3), Konka (11.8% market share, number 4), Changhong (10.2% market share, number 5), LG Display is said to have above mid teens market share. LG Electronics, one of the largest customers of LG Display, also has a 3.9% market share in the LCD TV market in China. The company has two module plants in China and plans to build an 8G plant (joint venture) in Ghangzhou, targeting the mass production from 2H2012. Given the growth of the LCD TV market in China (+119% YoY and +48% QoQ in 3Q09) and its exposure to top market share gainers, LG Display’s exposure is likely to rise.

Consumer

Orion (confectionary) – manufacturing facilities in Beijing, Shanghai and Guangzhou. China local sales for the first 9 months of 2009 were W315bn, 36% of Orion’s total confectionary sales. The revenue from China is expected to be more than W400bn in 2009. c.30% CAGR is expected in the China market by 2012. 

Amorepacific (cosmetics) – Two brands, Mamonde and Laneige are currently sold in China. Mamonde is manufactured in China and Laneige is exported from Korea. A premium brand, Sulwhasoo is to be launched in 2H2010, exported from Korea. China sales are likely to exceed W100bn in 2009, and the company targets 20% of total company sales (W3.7tr) from China by 2015. 

CJO Shopping (home shopping) – CJOS has exposure to China through a 30% owned subsidiary, Dongbang CJ, a joint venture with Shanghai Media Group. The subsidiary shows successful penetration in China’s home shopping market. Its broadcasting hours have risen and coverage includes Shanghai, Shandong, Nanjing and Hangzhou. 24 hour broadcasting is likely in Shanghai from the current 15 hours of broadcasting. So there should be more gains in 2010. Dongbang CJ booked W302bn gross sales for the first 9 months of 2009 vs. W1.2tr of gross sales in Korea.

Auto

Hyundai Motor Company (HMC) – The company sold 3.3mn cars globally in 2009, of which 18% was sold in China (598K cars, +78% YoY). Though strong sales volume was partially driven by a subsidy for small cars (below 1.6litres), HMC is gaining a market share in the China market, expecting to be c. 7% for 2009 vs. 5.5% in 2008. HMC has two plants in Beijing as a 50: 50 joint venture structure with full capacity of 600K cars. The market is expecting HMC to build the third plant (possibly 300K cars) in Beijing.  

Kia Motor under the Hyundai Motor Group also has a manufacturing facility in China, with production capacity of c. 280K in 2009 (max capacity of 430K). A total of 1.65mn cars were sold globally in 2009 with China sales volume accounting for 15% (241K, +70% YoY). Market share is estimated to be c. 3% in 2009. 

HMC and KIA together will target more than 1mn sales in China in 2010. 

Hankook Tire – China accounts for 14.9% of total 2008 consolidated revenues (replacement market of 10.3% and OE of 4.6%). Hankook Tire has two plants in China with capacity of 27.7mn units, 36% of the company’s total production capacity (77.1mn units). Local sales from China’s capacity is c. 65% in units and a little higher in value terms. The number 1 in market share (c.14% in 2008) in the China passenger car (replacement) market.

Looking beyond the surface

The Korean market may look less exciting on the surface from a growth point of view, but it is actually growing much more than it seems. With significant exposure to a growing market (China), I believe that Korea deserves a second thought.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

We begin with our view on developed market trends. Lifted by enormous policy supports, the longest and deepest economic downturn since the 1930s appears to have ended. Last quarter saw real GDP growth and it seems likely that the global economy will post another solid increase this quarter. However, growth has yet to produce a shift in private sector behaviour sufficient to generate the job gains that will be necessary for a self sustaining expansion in the developed world.

We do feel that the shift in the private sector will take hold in the coming months as the business sector responds to 2009’s surge in profitability, improvement in financial market conditions and synchronized global growth. Importantly, a modest change in business behaviour from depressed levels of activity can produce sustained above-trend growth. Thus, our forecast of a gradual but broad based move to an end of the de-stocking cycle, alongside an alignment of investment spending, will be sufficient to generate forecasted average developed world GDP growth of 3.5% in the coming quarters. Viewed from a historical perspective, this outcome should be seen as disappointing as these economies have tended to generate considerably higher growth after a deep economic downturn.

Tempering the powerful forces that have tended to lift the global economy, three meaningful drags persist: credit market tightness, which is expected to limit the recovery in investment and consumer durable spending; the lasting damage to household balance sheets; and job security, which is expected to promote further increases in household savings. If we are correct, the economic landscape will be marked by an unprecedented tension between persistent elevated growth and depressed levels of activity over the coming quarters.

In particular, we expect to see unemployment above 9% - two years into the expansion, expected growth will not be sufficient to lift operating rates meaningfully. High unemployment rates for labour have brought a remarkably sharp slowing in unit labour costs and wage growth. Core inflation is already low and set to be pushed lower by these supply/demand imbalances created by the recession. Thus, we anticipate core inflation to slide to a historic low.

These trends will clearly put the Fed on hold for most of 2010. With unemployment expected to remain high for some time and core inflation falling, it is unlikely that the FOMC will move policy rates higher this year. Actions to reduce the size of reserves may be taken if financial conditions improve, but rate hikes are not anticipated until late 2H 2010 at the earliest.

The emerging markets debt investment thesis for the past year was about country and region selection that would be least impacted by the expected reduction in liquidity that we saw in the third and fourth quarters of 2008. And the expected compression in risk premiums as global markets improved. Over the course of the year, our Global Emerging Markets Local Currency Bond Strategy had a distinct regional bias towards Latin America and Asia and away from Emerging Europe. In terms of portfolio strategy, over the course of 2009 we positioned the portfolio for a stronger-than-expected economic recovery and that the risk of a double dip recession would gradually dissipate as investors started to see increasing evidence of a more broad-based recovery. This positioning was supported by the fact that valuations were not stretched, investors still seemed more anxious and pessimistic than  warranted, and the ‘wall of money’ moving into risk assets seemed likely to buoy emerging markets debt. This portfolio positioning allowed us to achieve our expected alpha over the benchmark in 2009.

Whereas 2009 was a year of overall risk premium reduction, we feel that 2010 is going to be about country specific and yield curve specific selection in emerging debt markets. While there appears to be some life left in the risk premium compression trade, we think the time has come for investors to sharpen their pencils and focus on differentiation across countries and investment instruments. There is further room for re-rating emerging markets debt, but this is likely to be gradual and marginal compared with the violent market tightening of 2009.

After economic adjustments that ranged from abrupt to brutal last year, emerging market economies began to recover in the second and third quarters of 2009. We expect growth to be uneven across countries and regions, with commodity exporters likely to benefit most from the global recovery. Generally, subdued prospects should prevent inflationary pressures from emerging, but substantial differences in the pace of recovery are nevertheless leading to divergent monetary policies in emerging market countries.

A historical differentiation point of this crisis was that emerging market countries were able to pursue aggressive countercyclical policies, particularly monetary policy, for the first time. Emerging countries appear to be closing their output gaps on average at a faster rate than developed nations, and thus, one would expect them to tighten more aggressively than core countries. However, major uncertainty remains about the size of the output gaps, how that is exerting itself, and how robust global growth will be once we exclude fiscal stimulus and inventory accumulation. We expect the tightening process to be gradual and vary significantly from country to country.

All regions of the emerging world are in recovery. In Asia, the recovery is broad and mature enough to bring monetary policy tightening to the fore. Overall, it seems pretty clear that Asia will lead the recovery thanks in part to aggressive policy stimulus, notably in China. Since Asia’s recovery will be accompanied by some rise in inflationary pressures, policymakers in the region will need to tighten policy gradually through a combination of nominal exchange rate appreciation (including China) and rising interest rates.

With ample global liquidity going into 2010, recovery prospects for Latin America should be well supported, and here too there will be pressure on central banks to tighten policy. While some of that policy tightening will be achieved through currency appreciation, nominal interest rates will also have to rise, although in some countries not by as much as the market is currently pricing in.

Central Eastern Europe, Middle East and Africa (CEEMEA) will remain the weakest link in the emerging market story, particularly in countries whose pre-crisis growth rates were heavily supported by plentiful flows of credit. Low levels of credit extension will constrain recovery in these countries, particularly given relatively poor prospects for import demand in the Eurozone. Public finances will give more cause for concern in CEEMEA than in other parts of the emerging world.

On a top down basis, we expect emerging markets to play a central role again in 2010, but the story may change. Emerging Asia is likely to pass the baton to Mexico and emerging Europe – countries that were hit hard in the downturn. We do not expect a broad-based upturn in emerging world inflation, but emerging Asia – the region that led the global recovery – is likely to lead the return to inflation. Policy responses to inflation, using both interest rate and exchange rate tools, are likely to be a key issue for the year ahead.

In conclusion, we doubt that continued risk premium compression will be the dominant theme when we look back on 2010 as a whole. The market context will inevitably become more balanced as the financial conditions improvement matures. As it does, the broad, market-directional themes that have been our focus will need to be replaced by a renewed vigilance toward overshoots and corrections and, above all, an emphasis on relative value and asset selection – in other words, to rely a little less on beta and focus on alpha.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Market review

Global Emerging Markets continue to benefit from the extension of the “risk trade”. In November, the MSCI Emerging Market index rose by 4.3%, outperforming the MSCI AC World index (+3.9%). MSCI Latam led the charge rising by 8.3% over the month, while Asia and EMEA lagged rising by “just” 3.1% and 2.9% respectively. Year to date, Latin America is up 95.1% and this is the fourth successive month that the region outperformed GEMs.

Over the past month, global and regional equities shrugged off disappointing US labour market data, evidence of a flattening in the pace of Chinese economic growth, and the threat of default by Dubai World. The market appetite for riskier assets, based, above all, on the weak US dollar (down 2.5% on a trade-weighted basis in November), remains intact and inflows continue to provide support for equities. High-beta Mexico (+10%) and Brazil (+8.2%) were the best performing countries. The regional laggards were Turkey (-6.6%) and Korea (+0.8%), followed by China (+2.5%).

Outperformers in November were Materials (+8.1%) and, after earlier periods of underperformance, Healthcare (+7.7%). Telecoms (+2.9%) and Industrials (+1.8%) underperformed. Year to date, Energy and Materials are up 123 and 125%.

Market outlook

The credit crisis that triggered the collapse of global financial markets and sent most developed economies into a tailspin, now seems strangely distant after a record rally in the same financial markets that were teetering on the edge of self destruction only a year ago. As we approach the end of 2009, we can now “safely” say that emerging markets survived ‘the big ugly experiment’: a combination of a severe financial shock, the deepest developed consumer recession since WWII, the lagged impact of anti-inflation policies and a sharp drop in commodity prices. The main conclusion of the experiment is that the domestic inflation/monetary cycles were more dominant than external demand. At this time, we continue to remain positive on emerging market equities as the factors supporting the powerful recovery from the October 2008 lows remain in place. These conditions are: compression in excessive risk premiums, strong economic and earnings recovery, and overshoot as risk-free rates remain historically low.  2010 will likely be the transition year to whatever economic environment awaits investors for the next decade. With valuations in global credit and even equity markets no longer reflecting the risk of systemic failure, we believe (and hope) that expected fundamentals should again become the drivers of financial markets’ performance for the coming year.

Strategy

The strategy is overweight Russia, Mexico and Thailand, funded by underweights in Brazil, China and South Africa.

The strategy is overweight the Materials and Consumer Discretionary sectors. We are underweight Consumer Staples and the Energy sectors.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class. This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.  

Market review

After the correction in late October, Asian equities managed a small rise in November despite the problems in Dubai, Greece and Iran. Equities were helped by a G20 commitment to an ongoing policy stimulus, a 2% decline in the trade weighted US dollar and a 2.6% rise in the CRB commodity price index. The late November concerns about a possible default in Dubai have thus far proved relatively mild, despite the initial shock, with emerging market bond spreads only 2bps higher than at the start of the month.

India was the best performing market as the Government raised GDP forecasts. Industrial production rose 9.1% y/y in September and exports declined 13.8% in September vs. 19.4% in August. The central bank also bought 200 tons of gold for USD6.7bn from the IMF in order to diversify its foreign exchange reserves.

The major economic news in China was a continued fall in the CPI (down 0.5% in October). The trade surplus for October was USD24bn with imports down 6.4% y/y compared to a decline of 3.5% in September. Exports declined 13.8% y/y in October compared to a decline of 15.2% y/y in the previous month. Industrial production and retail sales rose 16.1% and 16.2% respectively y/y in October. The Chinese Government signed a MOU viz the Financial Access Pact with Taiwan and announced agreements with the US for climate change and green energy, and forecast GDP to be 8.5% for 2010. The major issue in the China market was concern over banks being asked to raise capital.

In Korea the Finance Minister said they might raise their GDP forecast for 2010 as the economy is expected to grow faster than their initial 4% expansion. Exports fell 16.5% in October while foreign exchange reserves stood at USD264bn. Samsung and Posco both announced major expansion plans in Korea. Meanwhile in Taiwan, exports only declined 4.7% in October and they had a USD3bn trade surplus. Industrial production rose 6.6% and foreign exchange reserves stood at USD341bn. There are high hopes for the Economic Cooperation Framework Agreement with China which will slash import tariffs and allow more market access in the financial sector from around mid 2010.

Market outlook

The credit crisis that triggered the collapse of global financial markets and sent most developed economies into a tailspin, now seems a little distant after a record rally in the same financial markets that were teetering on the edge of self destruction only a year ago.

As we approach the end of 2009, we can now say perhaps that Asian markets survived ‘the big ugly experiment’: a combination of a severe financial shock, the deepest developed consumer recession since WWII, the lagged impact of anti-inflation policies and a sharp drop in commodity prices. The main conclusion of the experiment is that the domestic inflation/monetary cycles were more dominant than external demand. At this time, we continue to remain positive on Asian equities as the factors supporting the powerful recovery from the October 2008 lows remain in place. These conditions are: compression in excessive risk premiums, strong economic and earnings recovery, and overshoot as risk-free rates remain historically low.

2010 will likely be the transition year to whatever economic environment awaits investors for the next decade. With valuations in global credit and even equity markets no longer reflecting the risk of systemic failure, we believe (and hope) that expected fundamentals should again become the drivers of financial markets’ performance for the coming year.

Strategy

On a country basis we are overweight Thailand and Korea and underweight Malaysia and Hong Kong. However, these under and over weights are now relatively small.  We have reduced, but are still running, an underweight in Taiwan.

Within sectors, we are overweight energy, materials, primarily cement, real estate and consumer discretionary, and are a little underweight telecom, consumer staples and capital goods. We are currently neutral on utilities (we like gas) and technology.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class.  This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Dubai has recently announced that state owned holding company Dubai World is to restructure $26 billion of its outstanding debt liabilities. Given the timing and the level of market surprise, there are potentially further ramifications for many related and non-related parties. The fallout following this event has already been felt in the portfolio valuations of investment managers across the globe, but what are the wider implications for investors, Dubai, the region and emerging markets generally?

Investors

It was obvious to investors that Dubai’s real estate developer Nakheel, a subsidiary of Dubai World, would be unable to sustain its onerous debt burden without external assistance. Its problems were high profile and well documented. The property market in Dubai had collapsed, consultancy fees remain unpaid and they were struggling to secure pre-construction sales on unfinished projects. Reading through their prospectus, it was also clear that recourse to sovereign assets was assumed, but not assured. Yet with the maturity of its $3.5 billion bond just two weeks away, investors were pricing the issue at par.

It is always easy to be wise after the event. However, long-held and complacent assumptions regarding sovereign support for quasi-sovereign bonds have already been challenged and subsequently ignored several times this year. Similar cases in Ukraine and Kazakhstan should have added to an ‘investor beware’ mentality, but these were seemingly dismissed by the market as idiosyncratic country risks.

The message to investors from the restructure of Dubai World’s debt is likely to be that it is important to price in the probability of parent/sovereign support more realistically. Invariably there will be doubt as to the level of support and investors will have to be more readily willing to analyse the debt sustainability of a quasi-government entity on a stand-alone basis.

Dubai and the Middle East

The widely held perception that Abu Dhabi stood behind all of Dubai’s debt has now been exposed as an illusion. The deafening silence from the oil rich emirate is further alarming the market. Additionally, we have yet to establish exactly why Dubai World is planning to restructure its liabilities. The financial cost to the region of restructure is ultimately likely to be higher than continuing to service the debt. Certainly at a sovereign level this appears more an issue of willingness rather than ability to pay.

Has Dubai’s unrelenting credit fuelled expansion finally snapped the patience of Abu Dhabi’s financiers, or was this default initiated by Dubai looking for an opportunity to establish greater independence? Less realistic, but also grabbing headlines, is the potential that the unknown off-sheet liabilities of Dubai are actually much higher than the market perceives and default is the only viable option.

What we do know is that Abu Dhabi banks purchased a $5 billion sovereign bond issued by Dubai just hours before the default was made public. This sent a strong message to the market that the financial link between the two emirates was assured. Ironically, this $5 billion issue was a tranche of a planned $20 billion sovereign issue from Dubai that was to be transferred to the Dubai Financial Support Fund, which in turn is to be used to financially support struggling government-linked companies.

Subsequently however, the government have been on record as stating that this fund was not directly linked to the restructure of Dubai World and it appears unlikely to be used to fund the payment of the Nakheel bond maturing on December 14th. Dubai has also gone on record as saying that the emirate is not the same entity as Dubai World and that creditors should take more responsibility for their investment decisions. This is potentially an ominous pre-cursor to an announcement of low recovery values for investors.

Information has been drip-fed slowly so far, but the treatment of debt holders by Dubai will be crucial in establishing how the emirate will be viewed by investors going forward. It is expected that foreign investors, of which the UK rank highly, will be treated equably in comparison to locals, but this is not yet cast in stone.

What is clear is that with the safety net provided by Abu Dhabi seemingly removed, the property market collapsing and larger write-downs looming, raising capital in the future in Dubai could be problematic. To be able to persuade investors that the emirate remains an attractive investment destination, Dubai will have to offer much higher incentives. Loosely worded disclaimers and complex ownership structures will no longer be tolerated.

The government owned utility Dubai Electricity and Water Authority yesterday announced plans to sell $2 billion worth of bonds in the first quarter of 2010 to finance expansion. How the market perceives this issue is likely to be a function of how Dubai resolves its current debt issues. In terms of reputation, the Dubai World default is already very bad for the sovereign particularly if it is perceived to be politically rather than financially motivated.

Elsewhere in the Middle East the implications of the default are less severe. Although credit default spreads on Abu Dhabi and Qatar sovereign debt initially widened quite significantly, they have now justifiably returned close to previous levels. The sovereign balance sheets of these countries remain strong, both enjoy an extremely low cost basis for oil production and both have accumulated strong external reserve levels and very high current account and fiscal surpluses. There is no reason as to why the Dubai restructure should cause a domino effect in the region. Any sovereign issuance is predominantly to provide corporates with a yield curve from which to price their debt. In the case of Abu Dhabi, it could be argued that the balance sheet is even stronger and its ability to service debt increase if Dubai’s liabilities are removed.

Global Emerging Markets

Historically, a sovereign default that could potentially be the largest since Argentina’s in 2001, would have implications for the cost of borrowing throughout emerging markets. However, emerging markets have been severely stress tested and survived the global crisis largely unscathed, so it’s unsurprising that the JP Morgan Emerging Market Bond Index spreads have hardly moved on the news of the Dubai crisis. This is further evidence of the resilience of emerging markets following positive structural changes that have occurred over the past decade.

We also believe there is little chance that this will affect systemic global risk appetite. It is unlikely that the scale is large enough to stall the global recovery, although it may mean that western banks with direct exposure to Dubai’s debt that have not adequately provisioned will once again need government encouragement to commence lending. If anything, events in the Middle East over the past week will act as another reminder to policy makers that the credit crisis has not yet been fully averted and will encourage them to maintain, or perhaps even increase, current liquidity provisions. This is an environment that will continue to benefit emerging market asset prices.

Certainly there is little if any direct ownership of Dubai debt across emerging market nations and scant reason for a wide ranging sell-off. At the margin, a slowdown in investment in Dubai will put pressure on the remittances of emerging market nations whose residents work on construction projects in the Middle East.  Of course, this is not to say that all emerging market assets will enjoy attractive returns over the next twelve months. The Dubai default will remind investors, who might have become a little complacent, that risks remain and 2010 is likely to see greater differentiation in performance between stronger and weaker sovereign credits.

One asset class that is likely to attract greater scrutiny as a result of the restructure is quasi-sovereign debt. It is widely thought that as a key generator of state revenue, Brazil would be unlikely to allow Petrobras to default on its debt should the company run into financial trouble. A similar assumption can be made for Pemex in Mexico, Gazprom in Russia and a whole host of other state owned entities across the emerging world. However, greater transparency will be required by investors in terms of sovereign guarantees and if they are not readily forthcoming, key public-owned sectors in the emerging market universe could find their cost of borrowing on the international capital markets greatly increased.

We believe over the longer term the implications of this restructure are positive as it brings to light another example of unsustainable financial wizardry built on very shaky foundations. If another global crisis of the magnitude we have seen over the past year is to be avoided, it is paramount that a global system that encourages sensible risk-adjusted borrowing and lending practice is in place. This latest news moves us one step closer to that ultimate position.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

We are taking some profits off the table in Brazil, reducing its weight within Rexiter’s global emerging markets portfolios.  What a year and what a breathless ride it has been! 

In US Dollar terms, the Brazilian equity market touched bottom almost exactly one year ago (21 November 2008). In the intervening year, the market has returned 180% from this low, with a gain of 135% in 2009-to date. This year, the Brazilian Real has been the best performing of the world’s major currencies against the US Dollar with a gain of 32% and is only beaten to the accolade of “world’s best performing currency” by the Seychelles Rupee. Rexiter owns stocks within Brazil that have recorded four-fold gains during this time. To us, it seems prudent to lock in some of these gains. Valuations have gone from bargain basement levels to a premium to the country’s own historical levels… although we view this as merited and reflective of the economy’s development.

The relative resilience of the Brazilian economy through the credit crunch has given rise to these stellar returns – the market should not have fallen as much as it did in 2008. Hence we have seen the rebound as investors realised that their first instinctive reaction from previous crises (SELL Brazil!) was a mistake this time around. Fifteen years of sounder monetary and fiscal policies laid the foundations for resilience, and swift and decisive policy action was successfully implemented. This is the first “crisis” in which Brazil has had the credibility and ability to cut interest rates and loosen fiscal policy to stimulate the economy, without destroying its currency. In the “old” Brazil, the first sign of international trouble would see the central bank forced to hike interest rates to defend the value of the currency… with the resulting crunch in economic activity a nasty side effect.

In fact, today the Brazilian authorities face the opposite problem – too much foreign capital seeking to buy Reais to buy equities or take advantage of 8.75% interest rates is pushing the currency stronger versus the Dollar. The unwelcome side effect of currency strength is feared loss of export competitiveness. Hence, the recent government imposition of a 2% tax on new foreign purchases of Reais destined for the fixed income or equity markets. Whether this measure is successful or not in slowing the appreciation of the Real, it will act as a headwind on the currency. We would tend to agree with the government that their currency looks expensive.

Brazil’s continued ascent onto the global stage, exemplified by the selection of Rio de Janeiro to host the 2016 Olympics, will throw the spotlight onto the challenges ahead. There is still much work to be done on issues common to developing the country and delivering the Games – improvements in security and infrastructure are paramount. This will only be achieved if the country can raise its level of investment (to over 20% of GDP) and keep it there. 2010 sees the end of President Lula’s term and a corresponding political transition. All the prospective candidates seem to agree on maintaining the broad policy objectives and economic direction in place now. However, candidates have differing philosophies and viewpoints and the devil is as ever, in the details. Brazil’s investment needs are such that it would be unwise to spook domestic and foreign sources of capital. Yet, we feel the market consensus is very (too?) relaxed about the election and the risks, however small, that lie within.

The investment party in Brazil goes on and can continue for many years if the right choices are made. It’s in full and colourful swing but just a little noisy and crowded at the moment so we are stepping outside to pause for breath… but we will no doubt be going back.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Market review

October proved to be a volatile month for equity markets as investors began to assess the relative merits of the "reflation trade" in light of the expectations of higher interest rates in 2010 and of a potentially prolonged period of time before any significant earnings recovery emerges. The MSCI Emerging Markets index resumed its positive momentum during the first two weeks of October and reached a new 12 month high by mid month (MSCI EM index level 975.9, +6.75%) before some profit taking saw the market finish flat. The market has now rallied over 95% from its low in March 2009, but remains 33.0% off its high in November 2007.

On the corporate front, over 75% of NYSE listed companies reported third quarter results that beat analysts’ expectations. On the economic front, the International Monetary Fund upgraded expectations of world economic growth for the first time in two years, to an overall +3.1% rate of expansion. The improvement was heavily biased towards developing economies, which are expected to grow by +5.1% compared with +1.3% in the more mature nations. Chinese GDP estimates certainly supported the suggestion of strong growth in the emerging economies. Third quarter growth was estimated at +8.9%, so strong that it sparked concerns of over-heating and speculation as to when the government might ease back the stimulus programme still in place.

Against this broadly positive backcloth, investors continued to embrace sectors with earnings leverage to an improving economy, although this theme now appears to be well owned and at risk of fading. The energy (+2.4%), materials (+1.60%) and financial (+1.1%) sectors outperformed while the information technology (-4.8%), utilities (-2.4%) and telecom (-2.4%) sectors lagged.

China outperformed on the back of stronger than expected domestic economic growth that resulted in higher commodities prices (the Jeffrey Commodity Price Index rose 4.5% during the month). As the main beneficiary of higher commodity prices, Brazil and Russia also outperformed. India, Korea and Taiwan underperformed.

Market outlook

After the rises of the past quarter, it is very tempting to take some profits and move to a defensive strategy - markets are, after all, up over 60% so far this year. We are not doing so.

Leading global economic indicators continued to suggest emergence from recession. Central bankers acknowledged the budding improvement, but given weak employment conditions in the developed world and the tentative flow of credit, they reiterated that removal of monetary stimulus likely remains a distant prospect. With liquidity worldwide staying flush and short-term investments offering a dismal return potential, funds continue to flow steadily into equities.

Within the asset class, emerging markets equities are in the “sweet spot” – global interest rates are low, the US fiscal position is taking its toll on the dollar (which supports commodities) and while developed market economies are improving, growth in emerging markets has already recovered and will continue to stay strong and stronger than that of developed markets for many years to come.

Two consecutive quarters of scintillating returns have swiftly reversed the despair that prevailed back in March and have now left equity markets measurably extended to the upside. A bout of profit taking could happen at any time, but even so, we expect any corrective activity to be short lived. Already paltry returns on short-term investments continue to erode, many investors continue to be sceptical about the recovery, short sellers are still abundant and the robust rallies in government and corporate bonds have made fixed income valuations much less competitive. With an average of 20-25% earnings growth to come in 2010 (risks to this consensus estimate are on the upside in our opinion), emerging equity ratings are not extreme and further progress does not require a re-rating.

Risks to watch include military escalation with Iran and an unexpected tilt towards central bank hawkishness, but the major economic trends still point to recovery. The chances for a broad array of earnings disappointments seem limited in the months ahead, and appear unlikely to reach dangerous levels until both expectations and share prices have accounted for recovery more fully.

Strategy

The strategy is overweight Russia, Mexico and Thailand, funded by underweights in China, India and South Africa.

We continue to maintain an overweight to the financials, energy (in particular exploration & production) and consumer discretionary sectors. We are underweight consumer staples and the information technology sectors.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class. This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

Market review

October proved to be a more volatile month for equity markets as investors began to assess the relative merits of the "reflation trade" in light of the expectations of higher interest rates in 2010 and of a potentially prolonged period of time before any significant earnings recovery emerges.

The MSCI Asia ex Japan index resumed its positive momentum during the first two weeks of October and reached a new 12 month high by mid month (MSCI AEJ index level 414.5, +5.0%) before some profit taking saw the market finish in negative territory. The market has now rallied over 90% from its low in early March 2009, but remains 33.0% off its high in November 2007.

On the corporate front, over 75% of NYSE listed companies reported third quarter results that beat analysts’ expectations. On the economic front, the International Monetary Fund upgraded expectations of world economic growth for the first time in two years, to an overall +3.1% rate of expansion. The improvement was heavily biased towards developing economies, which are expected to grow by +5.1% compared with +1.3% in the more mature nations. Chinese GDP estimates certainly supported the suggestion of strong growth in the emerging economies. Third quarter growth was estimated at +8.9%, so strong that it sparked concerns of over-heating and speculation as to when the government might ease back the stimulus programme still in place.

Against this broadly positive backcloth, investors continued to embrace sectors with earnings leverage to an improving economy, although this thematic now appears to be well owned and at risk of fading. The energy, materials and financial sectors outperformed while the information technology, utilities and telecom sectors lagged.

China (+6.44%) outperformed on the back of stronger than expected domestic economic growth figures. Hong Kong also outperformed the region (+2.73%) as employment statistics took a mild turn for the better, and property companies fared well as low interest rates and buoyant Chinese growth are keeping demand for real estate robust. Korea (-6.28%) underperformed as investors grew particularly worried about Korean restraints on appreciation of the won (the currency has appreciated 9% year to date and a whopping 28% since its low in March). Stronger than expected Chinese growth drove commodities prices higher (the Jeffrey Commodity Price Index rose 4.5% during the month), particularly the price of crude which was up 8.5%. As a result, India (large oil importer) underperformed (down 4.01% over the month).

Market outlook

After the rises of the past quarter, it is very tempting to take some profits and move to a defensive strategy – markets are, after all, up over 60% so far this year. We are not doing so.

Leading global economic indicators continued to suggest emergence from recession. Central bankers acknowledged the budding improvement, but given weak employment conditions in the developed world and the tentative flow of credit, they reiterated that removal of monetary stimulus likely remains a distant prospect. With liquidity worldwide staying flush and short-term investments offering a dismal return potential, funds continue to flow steadily into equities.

Within the asset class, emerging markets equities (both GEM and Asia ex Japan) are in the “sweet spot” – global interest rates are low, the US fiscal position is taking its toll on the dollar (which supports commodities) and while developed market economies are improving, growth in emerging markets has already recovered and will continue to stay strong and stronger than that of developed markets for many years to come.

Two consecutive quarters of scintillating returns have swiftly reversed the despair that prevailed back in March and have now left equity markets measurably extended to the upside. A bout of profit taking could happen at any time, but even so, we expect any corrective activity to be short lived. Already paltry returns on short-term investments continue to erode, many investors continue to be sceptical about the recovery, short sellers are still abundant and the robust rallies in government and corporate bonds have made fixed income valuations much less competitive. With an average of 20-25% earnings growth to come in 2010 (risks to this consensus estimate are on the upside in our opinion), emerging equity ratings are not extreme and further progress does not require a re-rating.

Risks to watch include military escalation with Iran and an unexpected tilt towards central bank hawkishness, but the major economic trends still point to recovery. The chances for a broad array of earnings disappointments seem limited in the months ahead, and appear unlikely to reach dangerous levels until both expectations and share prices have accounted for recovery more fully.

Strategy

On a country basis we are overweight China, India and Thailand, and underweight Malaysia, Singapore and Taiwan. However, these under and over weights are now relatively small.

Within sectors, we are overweight materials, primarily cement, real estate, consumer discretionary and technology, and are a little underweight banks, energy, consumer staples and telcom.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class.  This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.  

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.

Hark! 

A new financial sub-sector for the Korea Stock Exchange Index (KOSPI)!

Long life or short life…  or non-life?

The insurance sector on the bottom half of the Korean peninsula may be guaranteed neither to excite nor to hold the attention of the casual reader, but for operatives more closely involved, things are finally more than perceptibly changing, and roll up the “yo” (traditional Korean mattress rolled out on the floor for sleeping) and the “ondol” floors tell a tale!  Grimm meets Aesop! 

Life insurance comes with a hint of the possible oxymoron on a peninsula that remains to this day in a state of civil war 56 years after the cessation of formal hostilities and the signing of an armistice, a fact regularly attested by drivers and pedestrians on the streets of Seoul.  Life insurance companies were traditionally abused by their grateful and rapacious industrialising owners as a cash flow generator and as an oblivious in-house lending proxy for a bank to support capacity expansion, and all related efforts and expenses, in a host of me-too projects. Chaebol could not own banks, but they could own insurance companies. Very much the old Korea. 

Many projects and their supporting life insurance companies (around one third of all lifes) imploded in a horrendous asset-liability miss-match in the lead up to and in the backwash from the 1997 currency crisis.  Those that did not implode have been carrying the millstone legacy and will continue so to do for years.  Aigoo – interest rates, credit spreads and currencies moved when they should not have, and much credit became debit… terminally. 

Ten years on, resurrected life insurance is belatedly on the move to greater transparency and accountability as it starts listing its shares on the Korea Stock Exchange ahead of the need to comply with tougher international regulatory standards (Risk Based Capital and IFRS)!  As such this is to be applauded. The last significant financial sub-sector to come in from the unlisted cold, legacies and all. 

As of end September 2009, the Korea Stock Exchange had a capitalisation of W810tr (US$687.6bn) and financials represented 18.5% of the index, of which banks accounted for 12.96%, non-life insurance companies 2.21% and brokers 3.27%. Hence forward 2-3 years, listed life insurers could be capitalised at around W40tr for a weighting of around 5.5%, more than double the weighting of the listed non-life companies. To give the full index-weighted picture as of end September, Korea was 19.5% in MSCI Asia ex-Japan, and 15.3% in MSCI GEM. Korean life insurance companies could be 1.07% of MSCI Asia ex-Japan, and 0.81% of MSCI GEM!  Allocate that to your pipe and smoke it. 

How long have we waited for this?  The first rumbles of debate were picked up give or take twenty years ago, at the time of some initial deregulation letting in new operatives and foreigners in return for government tax incentives for the incumbents, and IPOs… crocks, gold or otherwise, at the end of the rainbow! 

But there were many impediments, crises of one kind or another, minor or major details depending upon who you were or how you looked at those details, and whether you were a participatory policy holder (ie thought you were entitled to a share of any listing as an effective mutual beneficiary) or not.  Therein lies the riddle.  The companies were/are joint stock companies rather than mutual insurers, but they had sold participatory policies which carry mutual baggage and mutual reward! 

Ministry of Finance bureaucrats and regulators, the courts and the politicians were for years tied in a Gordian knot. The Chaebol major shareholders (or owners) of the life companies may have wanted to list, but did not want to surrender the proceeds of the listing to the participatory policy holders. Minority abuse requiring rewriting of rules, if listings were to boost lagging solvency ratios for more business as usual. Needless to say, the moment the companies realised that there was a “mutual” impediment to listing, they offered only non-participatory policies, but it was too late as the participatory policies were out there and in force.

Politics, politics, politics. Ten years of purported distributive socialist government under the Presidencies of Kim Dae-Jung and Roh Moo-Hyun “wrestled” with the situation. 

The Alexandrian solution was many years in the making… finally arriving in April 2007 (by which time Roh Moo-Hyun was well into his lame duck period as President with only months to go to the next election). The Financial Supervisory Commission (FSC), the regulator, endorsed listing guidelines and defined policy holders as de facto creditors rather than de facto shareholders; list, up the solvency, and the minorities can go to… but there will be some form of subscription by all listing companies to a W1.5tr to a public fund for 20 years by way of recompense. Heard that one before.  Thanks.  

Scroll forward two and a half years, and the international institutional investor at the very least is required to sit up and take note; the passive fund manager will have to program in some new stock code numbers and learn some new names, even if the per force more sceptical active stock picker chooses to bide his time.

The first life insurance company out of the IPO traps was TongYang Life (082640.KS) which followed the less than resounding success of the Jinro “soju” IPO from Hite Holdings which had to be repriced. 

TongYang, variously ranked 6-8^th, listed its shares on the Korea Stock Exchange on 8^th October at W17,000/share, priced at the bottom of the indicated range of W17,000-22,000, implying a price to embedded value (EV) multiple of 1.5 times. This was a 50% premium to the listed second tier non-life companies trading at or below 1x unaudited EV (for the technically minded this is not an apple to apple comparison as life EV is all life, and non-life EV is ex casualty so material). On listing day the share opened at W15,700, a drop of 7.6%, and fell a further 9.9% to W14,150 in market hours.  As of mid-November it has just dipped below W14,000, 17% below its IPO price.  Small life scarcity seems now to imply only a 1.2 multiple to EV… or a 20% premium down from 50% at IPO. A good one to have avoided…?

A total of 20.2 millions shares were offered (10.75m new shares, 10% of the enlarged capital, and 9.27m existing shares, 8.2m from TongYang Capital and 1.07m from the Vogo Fund, a local private equity fund with its own propensity to attract headlines).  Post IPO the TongYang Group stake dropped to 49.5%. Institutions were allocated 66% in the IPO, domestic retail 20% and 14% went to the Employee Stock Ownership Programme (ESOP). W340bn was raised. However, it is of particular note that 46% from the 66% institutional allocation was taken by international investors. The retail portion was oversubscribed by 12.6 times, perhaps driven by the strong overseas institutional interest. Foreigners wanted it, the domestic institutions were not so sure and retail (gemi – ants) went with the international flow. For now it is a bit of ouch.

Who’s up next?  Korea Life (no.3), owned by Hanwha (good story behind this one), is in process for mid ’10 as is Mirae Asset Life (a tiddler). There are another five potentials; Dongbu Life, Kyobo Life (no. 2 – another good story involving Daewoo International, owned 35% by KAMCO and 11.2% by K-Exim Bank so government, itself up for “privatisation” and all three, owning 39.8% in Kyobo, just behind the Shin family’s 40.27% - rumours abound), Green Cross Life, Kumho Life, and the elephantine Samsung Life (no.1).  

The top three account for about 60% of sector assets, Samsung is 30%, and the top three are 55% of premium income.  

All will want to squeeze out into the market before Samsung Life arrives to kill investor appetite. It could be a busy few years in the flotation department with shuffling investment banking allegiances.  And Samsung could just play timing ball, as it has a raft of its own impediments… or it could not. There are reports that as of 16^th November, the company has requested proposals from prospective investment banks and securities companies to lead its IPO…!

Epitome and metaphor. 

Samsung Life lies at the heart of much that was and is Korea. It was founded in 1957 as DongBang Life Insurance, and employed widows from the Korean War as door-to-door saleswomen selling savings policies offering a slight premium over bank deposits. The founding family got into difficulties, and in 1963, the government arranged sale to the Samsung group. The name was changed in 1989, ahead of market deregulation which opened the market to new entrants, and foreigners.  As already mentioned, the sops were a tax exemption and proposed IPOs. 

More recently Samsung Life is embedded in the fourth act of the scrappy five act tragi-comedy that was Samsung Motors (SM).  SM was the Samsung group’s internally combustible and peccadillo attempt to enter the car industry from a wheel-less green field farm yard standing start in 1994 with rebranded Nissans. The first cars appeared in 1998 …ahem… just months after the currency crisis of late 1997. The virtual bankruptcy of the country killed domestic demand. Come back the Hyundai Pony, the Daewoo Tico and the Kia Pride, all is forgiven!  SM failed spectacularly under debt of W2.45tr from 14 financial institutions and spluttered into court protection in June 1999. SM is self-inflicted financial pain; no pleasure there. 

Group Chairman Lee Kun-Hee pledged to creditors 3.5m shares, or 17.5%, in Samsung Life. At the time these were claimed to be each worth W700,000 for a notional value of W2.45tr. It was also agreed that Samsung Life would list by the end of 2000. Any shortfall following listing/disposal would be made up by up to a further 500,000 shares from Mr Lee, and anything above and beyond would be guaranteed by 28 Samsung group companies. Done. And minority shareholders in the 28 group companies… By the way, the OTC price in Samsung Life shares was W477,000 prior to the reports of RFPs, but “jumped” to W653,000.  Ahhhhh.

But in the absence of the FSC ruling of April 2007 endorsing listing guidelines, at the time no more than a twinkle in the regulator’s eye, the previously eagerly anticipated Samsung Life listing unsurprisingly failed to happen by end 2000! 

So things slowly moved on. Seoul Guarantee Insurance sold 1.1m of the pledged shares in the OTC market (who picked these up?). Come December 2005, the frustrated creditors filed a law suit with the Seoul Central District Court against Mr Lee and 28 group companies claiming W2.45tr in principal and W2.88tr of deferred interest at a penalty rate of 19% per annum. The court’s first ruling took a further two years plus, and was finally delivered on 31^st January 2008 in favour of the creditors; sell 2.33m shares, a further 500,000 shares from Mr Lee to cover any shortfall, and any further shortfall to be covered by 28 group companies. The deferred interest rate applicable was slashed from the claimed 19% to 6%. The court thus required an adjusted W2.3tr settlement with future interest accruing at 6%. 

Within days in February 2008, Samsung appealed to the Seoul High Court. After due deliberation and 21 months, this court was due to present its final decision on 10^th November 2009.  It has baulked at the last, and has instead proposed arbitration, the first attempt falling on the same 16^th November.  Instead of agreeing a settlement, the IPO RFPs were disclosed…. A second attempt at arbitration will happen on 7^th December. Discounted closure around the corner? Maybe.  

The SM saga, together with ownership of Samsung Life and Everland (unlisted theme park operator and de facto Group parent) is at the heart of any potential restructuring of the Samsung Group, and the aspired generational transfer of control.  As of end September 2009, Mr Lee owns 20.8% of Samsung Life (post his earlier pledge of 3.5m shares), after various false name accounts “handed over” their shares.  Samsung Everland owns 19.3%, Shinsegae 13.6%, CJCJ 4.8%, the Samsung Foundation of Culture 4.7%, Samsung Life Public Welfare Foundation 4.7%, CJ Corp 3.2% and the ESOP 2.8%.

There is the issue of under-priced OTC warrants into shares of… Samsung Everland issued to Lee Jae-Yong, the crown prince, who now owns 25.1% of Samsung Everland (family stake 51.1%). So what?

The parent of US$173bn in revenues in 2008 and 20% of Korea’s exports

Source: http://www.forbes.com/2002/03/21/0321feat_6.html

Everland, the unlisted theme park, owns 19.3% of Samsung Life, which owns 7.3% of Samsung Electronics … add on the 38.4% that Life owns in Samsung Card, the 28.7% that Electronics owns in same Card, and the 25.6% that same Card owns in Everland … stir gently on the roller coaster and simmer, and any reader will be forgiven for feeling dizzy… but it is the business of life insurance that occupies this submission.

Korea is listed as the 7^th largest life insurance market in the world with a high penetration rate. Not bad for a country of 48.6million (World Bank, 2008). But that would suggest a mature market rather than a growing one. Lift the ”yo”, and it transpires that the historic base of life insurance is actually the sale of savings products, rather than protection policies. These were actuarily Long Term Mutual Savings Banks by another name. Protection product penetration is much lower, but is a growing market with an aging population. Over 15 years, foreign market share exploded from a very low base at the time of the Asian crisis to around 25%, but post-Lehman is fast evaporating – estimated at 14% and falling: there is a flight to domestic quality.  Absolute growth in the protection market compounded by recovering market share. Not bad for starters.

The asset side also has a rosy outlook. Institutionalised corporate pensions will be mandatory from end 2010. Current labour law and practices favour a retirement allowance whereby a company pays out in cash at “severance” one month salary equivalent for every year worked, but at the average monthly salary of the last three years worked. Where they have them, companies generally keep these allowances in cash on their balance sheets. That will change.  By end 2010, an estimated W50tr of retirement allowance cash will convert to corporate pensions and migrate to institutions joining the W9tr already migrated; and then there will be the annual contributions, maybe as much as W80tr from 2012. No problem gathering assets, they will come. Two down and just one to go!   

So, management and their abilities to manage, and to price and manage risk?  How many CFO’s and members of senior management are internationally qualified actuaries? How many understand EV?  Comprehension and qualification may just not reside in great depth. Recall that these companies managed to miss-price their savings policies offering long term fixed rate guaranteed returns which looked good back then, but have been legacy millstones for years, eroding solvency. Legacy issues still have years to run but that in itself could represent an opportunity. But are the inevitable IPO premium expectations to EV justifiable? Management probably has much to prove in entering a listed world…

Actuarily, Meatloaf may neatly sum it up in one of his songs; “Now don’t be sad, don’t be sad, ‘Cause two out of three ain’t bad”.

So, index impact significant, and market impact significant. Premia to EV? Long life, or short life? Or pair trade with non-life? Or long non-life?

Once the IPOs are out of the way, the dust settles, and tricks are learned, there could be something here for the long term return on EV. We shall see, but whatever, we will all have to take note. 

And long life, short life or non-life north of the DMZ?

Life expectancy north of the DMZ at birth is around 63.8 years compared to 78.7 years to the south. That suggests a 15 year premium for South life versus North non-life …

But life does seem to go on, just, amidst reports of floods, expected food shortages, of stand-in doubles and ever slimmer and more gaunt images of the Dear Leader, Kim Jong-Il. His reported schedule of on-the-spot utterances suggests some recovery in his health, but grave suspicions remain. Missiles are readied, ships loose off, and now there are suggestions in certain quarters that the Dear Leader may have “weaponised” water in two unprovoked water attacks on the south.

On 27^th August, the DPRK discharged 7,400 tons of water a second for two hours from one dam – this attack seems to have been dealt with, presumably with the help of river banks, gravity and ultimately the sea, and hushed up. Recon, probing, or skirmish? Just days later there was a second more devastating attack over a weekend involving 40 million tons of water released at 1,500 tons per second from the Hwanggang Dam. The Imjin River rose 2 metres, and six southern campers were lost.

But at an individual level perhaps the state of life and non-life is encapsulated by the highly contrived, but very limited and occasional, family reunions between North and South. There are an estimated 600,000 people in the South with relatives in the North. In late September, 97 South Koreans met 228 members of their North Korean families at the Mt Kumgang resort in the DPRK, and a matching 99 North Koreans met with their relatives from the South. This was the 17^th round of such reunions but the first for 23 months; the first reunion happened in 1985. 

As ever the scenes throughout, but particularly at the end, were harrowing melodrama made for television.  Family members permitted to spend a few hours together in contrived situations for the first time in almost 60 years with no interim contact or knowledge, and then it was all over. They will probably never see each other again. Demand is high and capacity is a couple of hundred a time. The lucky few will consider it worth the few hours despite the pain, the unlucky many may never ever get to see their families as everyone is getting older. Things move slowly in North-South relations. What a life.

I bet he drinks Carling Black Label…well Taedonggang Maekju!

There has somewhat unusually been summer movement in the DPRK beer and broadcasting markets. Back around the turn of the century, Ushers, a British brewery, sold a surplus plant to the DPRK for a reported Stg1.5m; the plant was dismantled on site by North Korean technicians, and shipped to the DPRK for reassembly.

It has been producing beer under the brand “Taedonggang Maekju”, (Taedong River Beer) and in July, the Korean Central News Agency broadcast its first beer commercial claiming the beer was the “pride of Pyongyang” and that it was brewed to international specifications under the ISO 9001 quality standard. No mention of whether it was probably the best lager in the world… or the parts that it may or may not reach!

A number of other commercials promoting inter alia ginseng and quails were also produced. Cha Sung-Su, Chairman of the Central Broadcasting Committee, was apparently responding to instructions from Kim Jong-Il to “produce more interesting and diverse programmes”. Cha, 69, is known as being close to Kim Jong-Il, has been a regular companion on trips of inspection, and was the top TV man north of the DMZ, having served on the Central Broadcasting Committee for four decades.

It seems that the beer commercial, on closer viewing by the Dear Leader, did not live up to expectations. He expressed his strong disappointment, stating “they are as degrading as the ones that China had in its earlier reform”. Those were presumably the source of Mr Cha’s artistic imitation….errr…inspiration...anyway, he will be broadcasting little for now, as he has been sacked. Take a look at the following link to see why - http://news.bbc.co.uk/2/hi/asia-pacific/8132199.stm.

Satellite image ….of the Taedonggang Maekju malt reprocessing plant

Source: news.bbc.co.uk/2/hi/asia-pacific/8110093.stm

And the DPRK at the 2010 Soccer World Cup in South Africa!

….rumours abound of an approach made to Sven-Goran Eriksson, former national coach of the England soccer team to accept a coaching position for the DPRK team at the World Cup. His record suggests that he will look at most things both on and off the football pitch, but this seems to have been a pitch too far.

Life for Eriksson would not seem to be on the peninsula.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

The MSCI Emerging Markets index rose 21% in the third quarter of 2009 and has surged 60% in Q2/Q3’09, making them the best two quarters of return on record. Year-to-date the MSCI Emerging Market index has risen up 61.2% driven by the strong performance of Brazil (+97.0%), India (+86.4%) and Russia (+81.4%).

Emerging Markets currency returns, as per the JP Morgan ELMI Index (a basket of 24 EM currencies), rose 4.4% in Q3; EMBI spreads fell 98bp to 327bp; commodity prices, as per the CRB index, edged up 3.8% in Q3 and oil prices rose 1% during the same period. Global credit markets rather than China and commodities were the main drivers of the strong equity performance during the third quarter. EMEA equities (+20.0% in Q3) benefited from a recovery in Europe and the rally in global bank stocks; LatAm equities (+24.0%.in Q3) continued to be buoyed by lower rates, risk appetite and global growth upgrades; Asia (+18.7%) was held back by worries over China policy tightening.

Market outlook

After the rises of the past quarter it is very tempting to take some profits and move to a defensive strategy – markets are, after all, up over 60% so far this year. We are not doing so.

Leading global economic indicators continued to suggest emergence from recession. Central bankers acknowledged the budding improvement, but given weak employment conditions in the developed world and the tentative flow of credit, they reiterated that removal of monetary stimulus likely remains a distant prospect. With liquidity worldwide staying flush and short-term investments offering a dismal return potential, funds continue to flow steadily into equities.

Within the asset class, emerging markets equities are in the “sweet spot” – global interest rates are low, the US fiscal position is taking its toll on the dollar (which supports commodities) and while developed markets economies are improving, growth in emerging markets has already recovered and will continue to stay strong and stronger than that of developed markets for many years to come.

Two consecutive quarters of scintillating returns have swiftly reversed the despair that prevailed back in March and have now left equity markets measurably extended to the upside. A bout of profit taking could happen at any time but even so, we expect any corrective activity to be short lived. Already paltry returns on short-term investments continue to erode, many investors continue to be sceptical about the recovery, short sellers are still abundant and the robust rallies in government and corporate bonds have made fixed income valuations much less competitive. With an average of 20-25% earnings growth to come in 2010 (risks to this consensus estimate is on the upside in our opinion), emerging equities ratings are not extreme and further progress does not require a re-rating.

Risks to watch include military escalation with Iran and an unexpected tilt towards central bank hawkishness, but the major economic trends still point to recovery. The chances for a broad array of earnings disappointments seem limited in the months ahead, and appear unlikely to reach dangerous levels until both expectations and share prices have accounted for recovery more fully.

Strategy

The strategy is overweight Russia, Mexico and Thailand funded by underweights in China, Israel and South Africa.

We continue to maintain an overweight to the Financials, Energy (in particular Exploration & Production) and Consumer Discretionary sectors. We are underweight Consumer Staples and the Information Technology sectors. We are further increasing Russia, Mexico and Technology, funded by reductions in Israel, Czech Republic and Malaysia.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class. This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector.

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients. 

In the third quarter the MSCI Asia ex Japan index rose by 18.99% - another strong performing quarter.

Third quarter drivers were global credit markets rather than China and commodities (CRB index up 3.8%). Global bank stocks recovered somewhat while markets continued to be buoyed by low rates, increasing risk appetite and global and Asian growth upgrades. Asia was relatively held back by China due to worries over its future policy tightening. Asian and emerging market equities were big outperformers of developed market equities. Additionally, Asian and other emerging currencies rose versus the USD.

During the quarter Indonesia rose the most up 37.75% in USD whilst Korea was not far behind up 34.46%. Taiwan rose 22.46%, helped by continued cross straits hopes and the technology sector, and India 19.6%. Meanwhile China rose a more modest 7.82%, Hong Kong rose 14.41% and Malaysia 14.82%.

Industrial production and retail sales rose 12.3% y/y and 15.4% y/y in China supporting growth recovery. Indian industrial production rose 6.8% in July y/y lower than the 8.2% y/y in June.

Market outlook

It is unusual for the US market to manage two consecutive quarters of double digit gains, so after the strong Q3, it is possible statistically that Q4 could be difficult if you go by this. Historically it has only happened 7 times since 1918 (source: Merrill Lynch – 1st October Asia and GEM wrap – September 2009). However, in the ‘exceptional periods’ when equities did rise, equity returns were highly correlated with corporate bonds. Thus, if credit does well, equities should follow. Since we are in a period following a credit crisis it does not seem unlikely that this is an ‘exceptional period’.

Emerging Asia currently trades on 15.6x 2009 earnings and 12.4x 2010 (source: IBES/Credit Suisse Daily 5th October 2009) which looks reasonable given 26% earnings growth in 2010. The current estimates for 2011 are for 20% EPS growth so again this would lead most investors to a positive outlook and we would concur with that. Clearly markets have to ride a collective ‘wall of worry’ regarding the outlook for developed market growth and deficits but assuming gradual western recovery, Asian markets should move upward and continue to outperform developed markets.

Strategy

On a country basis we are overweight China, India and Thailand and underweight Malaysia, Singapore, Taiwan and Korea. However, these under and over weights are now relatively small. Within sectors we are overweight materials, primarily cement, real estate, consumer discretionary and telcom. We are a little underweight banks, energy, consumer staples and capital goods. We are currently neutral on utilities (we like gas) and technology, but have recently added to the latter.

In keeping with our core philosophy, we are seeking to maintain a fully invested, fully diversified exposure to the asset class.  This does not mean we are looking to take risk out of the strategy, rather that we are trying to diversify that risk by country and sector. 

CAUTION: The opinions expressed in this document are the views of Rexiter Capital Management Limited. This document is intended for institutional investors only and is not suitable for retail clients.