An Interview With Mark W. Headley, Portfolio Manager, Matthews Pacific Tiger
by Maria Crawford Scott
Many investors pronounced the Asian region dead after the financial crisis in the late 90s. To make matters worse, it appeared that the diversification benefits had diminished, as the Asian markets for several years moved in lock-step with the U.S.
Yet there have been recent sparks of life in the region. In a surprising comeback, the Asian region, excluding Japan, has offered some bright spots in a very down market year for U.S.-based investors.
One regional fund that has performed very well relative to its peers is the Matthews Pacific Tiger Fund. The fund was among the top 25% of international regional stock funds for the first quarter of this year, as well as the last year and the last three years (through March 30).
Currently, the fund has about $110 million in total assets.
In early May, portfolio manager Mark W. Headley discussed the management of the fund with Maria Crawford Scott.
What is the investment philosophy of the Pacific Tiger Fund?
The Pacific Tiger Fund seeks to provide long-term growth by investing in the Asian Tiger region—Asia excluding Japan—which we believe will continue to be one of the most dynamic growth regions of the world.
Were basically looking for good growth at a reasonable price in a business that we can understand.
Although were growth-oriented, were constantly looking for the best combination of growth and value. We dont want to pay too much, so were looking for misunderstood stocks—companies that are maybe down because people dont like the general environment, but where we think the long-term trends are positive.
We stay 99% invested all of the time. Occasionally, we have a somewhat higher percentage in cash because some money has come in and were taking our time putting it to work. But in general, were fully invested.
Most of our stocks, approximately 90%, are either in the consumer retail sector, finance sector or broad-based technology telecom sector.
Were not biased by market capitalization, unlike most Asia-ex-Japan investors who tend to stay in the large caps. Right now the portfolio is 30% large cap, which we define as over $5 billion, 45% mid cap, which is $1 billion to $5 billion, and 24% small cap. Thats fairly typical, although Im buying a few more small companies at the moment because the best domestic participation, particularly in consumer retail stocks, is through the smaller companies.
The companies that weve always specialized in and that have typically been close to 50% of the portfolio are mid caps. Over the years, weve raised that mid-cap definition some, but we still find mid-sized companies that have good track records, mature businesses and yet are small and nimble enough to really take advantage of new opportunities, arent too diversified, and they often have one core business—whether its a clothing retailer or a domestic bank.
We have long avoided too much exposure to the Asian conglomerates—the GEs of Asia. There were a lot of GE wannabes and frankly there arent many Jack Welches out there who can run 10 different business divisions and have it make any sense in the long term. We like focused companies—whether its a brewery or a mobile phone company thats in a specific niche.
Right now, were very encouraged by smaller companies in Asia, but on the other hand I think the blue chips are pretty attractive. We just dont like big conglomerates in general, with a couple of exceptions. We also dont like property companies, which continue to be, in Hong Kong, many of the blue chips. And we generally avoid cyclical stocks.
We like organic growth. We prefer companies that can really drive their earnings growth rather than a commodity company or a property company.
Were looking for good exposure to the economies. Wed like to be between 10 and 15 times earnings and wed like to have over 20% earnings growth. Thats the ideal position of the portfolio.
But were not doctrinaire on a quantitative basis. Frankly, a price-earnings ratio in Thailand may not really be equivalent to a price-earnings ratio in Hong Kong. Every industry has its own characteristics.
Were forced by the environment in Asia to be relatively flexible. These are financial systems that are evolving—and sometimes devolving—relatively rapidly. We cant run around with one measuring rule, and thats something that frustrates American portfolio managers quite frequently.
We generally say that country allocation is a derivative of the stock selection process, but there is always a consciousness of political risk, economic change and, very importantly, actual market structure.
Taiwan has some wonderful tech companies. Theyre a little cyclical and theyre not the cheapest companies in Asia, but theyre great companies. Unfortunately, theyre in Taiwan, and Taiwan continues to have a government that manipulates the stock market on a regular basis. We put a real discount on that sort of situation.
Were also very conscious of liquidity. You need local investors. In a market like Thailand, the local investors took such a horrendous beating in 1997 and 1998 that many of them havent returned to the market. And so beyond the top five or 10 names, liquidity is a huge problem.
When looking at companies in these various countries, you have to really balance these things out, and try to understand the quality of the earnings of the company. In some cases, debt is totally appropriate, in other cases, I understand why management keeps a cash reserve. When youre operating in Indonesia and you know that theres no international financing available to you for the foreseeable future, you like having a couple hundred million sitting in the bank. Whereas the Korean companies that run huge manufacturing businesses, I understand why they have significant debt. Many constantly have to reinvest—if you dont, you die—and that requires significant borrowing.
Those things all factor in to what is a constant search for well-managed companies in a growth area.
We find the company visit to be invaluable. By talking to people in many different industries about their struggles and their competition, I get my best feel for the landscape of Asia.
We also want to make sure we understand how management views us as shareholders: Whose interests are really in the forefront—the controlling shareholder or all the shareholders? There is no doubt that minority shareholders in Asia are getting a much better deal than they ever did in the past, but theres still a long way to go, and there are still companies that havent gotten it. And in any booming investment environment you have to worry that theyll forget it as well. You cant be complacent about any of these companies.
Obviously, we are still positive on the region. In Asia the whole tech rush lasted about nine months—there was this sharp run-up in 1999, and then 2000 was horrendous. And that reinforced many investors feelings that Asian countries really had not reformed after the 1998 financial crisis. Our feeling was that 1999 was too much, too fast, and 2000 was a healthy retrenchment.
In Asia, the worst of the damage came through right at the end of the year as Asian economies really felt a U.S. recession coming on. Asia is right at the beginning of the supply chain for so much U.S. consumption—particularly on the tech side. The market sold off brutally and then did surprisingly well in 2001.
The markets that really havent come back are Thailand, Indonesia, Malaysia and the Philippines. And Singapore has been dull since the 1998 crash.
Were starting to see some life there again, which is encouraging, and weve started to move some money back in—mostly from Korea, where weve just had tremendous performance and we consequently want to cut back a bit.
Obviously, diversification is important in any fund, particularly in a volatile area like Asia ex-Japan. We still dont have any money in Malaysia or the Philippines for various reasons, but we have increased Singapore some.
By and large we continue to really focus on finding companies that make sense to us, finding companies that are benefiting from the reform-and-restructuring process that we see going on with the majority of Asian economies. The positive thing is that the excesses in Asia were wiped out over the last few years. Companies have reduced debt substantially, theyve spun off non-core assets, theyve laid off a lot of workers. And companies also have been working very hard to diversify their earnings sources. The best example is Korea, where exports to China are poised to exceed exports to the United States. Thats a tremendous shift for the Korean economy.
In fact, today global investors are all excited about Korea—you cant open the newspaper these days without reading another article about the Korean economy moving ahead. Thats the time for us to ease out a little bit, since we had been overweighted there relative to our peers. Weve watched the market double in a year. Thats an incredible turn. It probably needs to just consolidate for awhile.
Were still very positive on Korea in a three-year outlook, but I think Thailand, Hong Kong and Indonesia are very undervalued and they really havent gone anywhere significantly over the last few years. I see very little downside, a lot of upside in those markets.
Korea has made great strides. Thailand is now a much more stable situation. Indonesian and Philippines politics remain a big question mark—I think those are the primary countries where politically youre still putting a big question mark over whats going to happen next.
But you have to realize that it varies for each market, for each industry, for each country—thats always the challenge. Its common to talk about Asia in the United States. Even though Thailand and Korea are both economies that have done significant restructuring, theyre totally different countries.
Thailand is still a predominantly agricultural country that earns most of its dollars selling rice and tourism. Their industry is mostly light, although theyve just starting an auto manufacturing industry.
Compare that to Korea, which is one of the premier manufacturing economies in the world—and the whole structure of the financial system reflects that to a certain extent. What you see is a banking system that is getting back on its feet, consumers who are getting access to capital, and well-run companies that are doing quite well.
The Taiwanese are pouring money and people into China as fast as they can. The government of Taiwan is terrified of this and trying to slow it down, but they cant—Taiwanese companies will go out of business if they dont go into China, and they know that. On the other hand, you have this very tough political problem as to sovereignty, and it would enormously benefit Taiwan to work out some sort of deal with the Chinese.
China keeps motoring ahead and Im afraid Taiwan will be left behind if it doesnt find a way to overcome the political impasse. Were very cautious on Taiwan for that reason, and for the market manipulation reason I mentioned earlier. Were very bullish on China long term, but we see Hong Kong as by far the best way to play China.
Absolutely. I think economically theyre linking up at a pretty rapid rate. What Hong Kong has really suffered from, and Singapore too, is that these are trading cities and global trade has gone through a pretty ugly dip. But these two will be the real beneficiaries of an increase in global trade in the long run. And Hong Kong is also going to reap more and more from the role it plays for China. Its no longer Chinas physical window to the world—China doesnt need a physical doorway. But China doesnt have the legal system or the financial system to deal with the global clout of the markets. Thats Hong Kongs role.
One of the most exciting prospects for us longer term, over the next five years, is that China really is opening up a vast array of industries—and the financial industry is one of them. These good-quality financial companies, particularly in Hong Kong, are going to have a real opportunity to go into China—whether theyre building their own network or making an acquisition. That to me is very exciting because Ive watched how quickly China can adapt to a new system.
It was actually the devaluation of the Thai currency that started it, but then the Malaysian prime minister became very vocal in criticizing foreign hedge funds, and then he put on capital controls—essentially, foreign money could not leave. We have a real problem with that, and we will not forget. We may someday forgive, but the fact is that he still has not renounced that policy. So if there is another crisis, I can be fairly certain that Malaysia will slap on capital controls. That to me is really unacceptable running an open-ended fund—thats a huge risk.
I have to admit, there are a couple Malaysian stocks that Ive owned in the past and Im tempted to look at now. But Ive decided to participate through Singapore, where we see continued good corporate management and good government policies. We just added Great Eastern Life, the largest life insurance company in Singapore, which receives 20% to 30% of their business from Malaysia.
Any country can have a political crisis, can have an economic crisis, can have a financial crisis. There are those great global events when everybody gets hit. Then theres individual country risk. As an Asian investor, you have to be conscious of that.