Out-of-favour stocks are 'where opportunities lie'

Mr Gibson says undervalued stocks may perform poorly in the short term but the investor will be more than compensated for that in the long run, perhaps on a five-year basis.
Mr Gibson says undervalued stocks may perform poorly in the short term but the investor will be more than compensated for that in the long run, perhaps on a five-year basis.ST PHOTO: AZMI ATHNI

In our monthly series featuring leading financial experts and fund managers, Kevin Gibson, chief investment officer for equities at Eastspring Investments, looks at value-investing in the Asian stock market.

Asian stock market valuations have hit lows last seen in the financial crises that hit in 1997 and again in 2008 but one equity expert sees this as a great buying opportunity for investors.

Mr Kevin Gibson, chief investment officer for equities at Eastspring Investments, told The Sunday Times: "Emerging markets are now very cheap, relative to developed markets.

"From 2009 to 2011, after the great financial crisis and China's aggressive reflation, we saw emerging markets performing strongly.

"But since 2011, there have been doubts about the sustainability of China's policies, non-performing loans and the real estate market, and emerging markets have underperformed significantly since then.

"Expectations are very low now, and that's why we have this one-in-10-year opportunity."

In choosing undervalued stocks, Eastspring comes up with a value on a business analysing revenue growth, margins and cash flows, for example.

"We then try to take advantage of pricing anomalies, where the current share price is much cheaper than what the business is worth," Mr Gibson says.

He explains such opportunities arise because people's behavioural biases drive share prices, causing them to move much more than the fundamentals of a business would suggest and deviate significantly from its underlying value.

So lingering doubts about Asia's markets do not deter Mr Gibson, who has been with Eastspring for 12 years and manages US$33 billion (S$44 billion) in assets under equity. The company is a wholly-owned subsidiary of Prudential Corporation Asia and focuses primarily on investments in the region.

"People take comfort in following the majority but that's not very sustainable in the long term, because perceptions around stocks change and if a stock is overvalued, it is likely to underperform," he says.

Eastspring has positions in stocks that "will perform poorly in the short term". Mr Gibson says; "We are patient and look at investing in a five-year time frame.

"My background is in Japanese equities and they have this saying in Japan, 'you hammer in the nail that sticks out'. To be seen as different is something people are uncomfortable with.

"But I've always liked to do things differently. Contrarian investing, buying out-of-favour stocks. Nobody loves them, but that's where the opportunities are."

Q What is your outlook for Asian stocks?

A We look for undervalued stocks within Asia and now the markets are all so cheap, it's a one-in-10-year opportunity.

If you look at Asia ex-Japan, the average price-to-book valuation for the market has been 1.9 times for the last 20 years.

Now it's around 1.4 times, and that's Asian and great financial crisis lows. History shows that every time you buy with the market below 1.5 times, the return on a five-year basis is a 100 per cent upside.

But we've also observed big valuation bubbles in certain sectors, driven by quantitative easing and a surplus of cash and capital.

Given the uncertainty in the global economy, investors have been buying quality stocks - safe and stable companies with high profit margins and low variability of these margins - because they expect these businesses to remain relatively unaffected.

So some parts of the market are extremely expensive on a price-to-book and price-to-earnings basis. We've underweighted pharmaceuticals and consumer staples.

Q Which sectors have you overweight?

A We've overweighted financials and real estate. Real estate, because people are looking at the excess supply now, thinking prices will be under pressure, impacting the earnings of real estate developers, and extrapolating that to the future.

For financials, we have large positions in banks here, DBS and OCBC.

Their share prices have performed very poorly because investors are concerned about their exposure to commodity-related loans.

But from our analysis and engagement with the management, we think these concerns are overdone and the shares are significantly undervalued.

Japanese bank stocks are also significantly undervalued.

When the negative interest rate policy was announced, all Japanese bank stocks fell 10 to 15 per cent and continued to perform poorly.

What the market was saying was that a negative interest rate is bad for banks' short-term margins. But what the market was doing was also extrapolating that and expecting it to continue.

We don't know when interest rates will normalise. Maybe in the next five years, but within that sort of environment these stocks are significantly undervalued and that's an opportunity we want to exploit.

Q How has the Japanese equity market changed since Abenomics was implemented?

A There's been a greater focus on improving return on equity.

Abenomics was implemented two to three years ago with its three arrows of monetary policy, fiscal policy and structural reforms but we'd already observed a fundamental change in Japanese corporate management prior to it.

Companies now look to maximise shareholder returns when in the past they would have focused more on their customers and employees.

They've realised that with increased globalisation and the emergence of Chinese corporations, they have to re-engineer themselves to improve profitability, increase dividends and improve returns.

So when Abenomics came along, it was just continuing with corporate governance reforms that had already been embraced by companies.

The Bank of Japan's aggressive quantitative easing has also led to rising inflationary expectations, such that savers in Japan are demanding higher returns.

Money is going from traditional bank accounts into stock markets. The government pension investment fund is increasing its allocation to equity as well, putting pressure on corporations to improve return on equity.

But all this has yet to be priced in by the market. Expectations of the reforms working are very low, so the market is very cheap.

The risks are more on the upside than downside.

Q What are some risks investors should note?

A The risk is that valuations might remain cheap for a long time. But you'll be more than compensated for that in the long run, perhaps on a five-year basis.

Markets get to valuation extremes because human emotions are very volatile. People's expectations can get very bearish, which is why you can buy at such incredibly low prices.

But the bad times won't last and you actually see many businesses cutting costs aggressively and becoming leaner and meaner during this time.

We've underweighted some markets though - India and the Philippines.

The Philippines has been a strong performer. Its reform agenda has raised expectations about economic growth and returns from the market, and risk appetites have fallen considerably. That's resulted in a very expensive market.

India is another market where reform expectations have been high, with Mr Narendra Modi elected as Prime Minister and the governor of the central bank implementing successful monetary policy that has brought inflation under control. This has led to expectations that returns will follow through, and expensive valuations.

Ultimately when making investing decisions, I think you should always understand the downside, and if you can live with that, proceed.

Too many people think about how much money they can make without understanding what could go wrong.

Q Where do you see opportunities in the Asian stock market?

A Apart from Japan, Singapore and Hong Kong, because we like the financial sector, as I mentioned.

A controversial stock we like is Noble Group.

The share price has been extremely weak because of the short selling, doubts about its accounting policies and collapsing commodity prices.

Investors got concerned about the solvency of the business and the share price went down, and then they got even more concerned.

But the management made significant strides in rationalising the business and selling non-core businesses.

Coupled with the recently announced rights issue, we think the business is financially strong now.

A version of this article appeared in the print edition of The Sunday Times on July 17, 2016, with the headline 'Out-of-favour stocks are 'where opportunities lie''. Print Edition | Subscribe