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By Scott B. MacDonald

NEW YORK (KWR) -- During the 1980s and 1990s up until 1997, non-Japan Asia demonstrated dynamic growth and sucked in billions of dollars and yen of investment. The ensuing financial crisis, which rocked the region from 1997-1998 and threatened to pull down an already wobbly Japan, drove many foreign investors away – both from the equity and bond sides of the business. The investment terrain was left to vulture investors, hardy funds with local expertise looking at direct foreign investment and a smattering of entrepreneurial individuals. In 2003 Asia once again beckoned for both bond and equity investors. That trend is likely to continue in 2004.

The question is – how do investors find compelling stories?

Although some investors look for investments by making a bet on macroeconomic conditions, smart money usually finds a compelling investment story based on key developments in a particular company. What we mean by key developments can be translated into finding a company that has a “story” to tell. That story can be one based on restructuring, a new product, regulatory changes, or a merger and/or acquisition. Free cash flow is also important as well as how transparent are a company’s financial statements. Consequently, one is left looking for triggers – major developments that will determine the company’s performance. Good investment opportunities can be found even in difficult economic and political conditions.

Consider the banking sector in Asia. Although investors have demonstrated little interest in banks in China and Vietnam (for good reasons), there has been and continues to be interest in largely private sector banks in India, Thailand, Malaysia, Hong Kong and Indonesia. The reason for this is this is that in each case, the regulatory environment has improved and measures have been taken which are more constructive for banks to operate. Within these countries the bank stocks likely to do the best are those tied into the regional dynamics of a growing middle class (with their demands for mortgage financing), key consumer goods, ongoing implementation of technology (helping introduce greater cost efficiencies) and improved transportation (which is encouraging the greater use of autos).

Two of India’s major commercial banks, ICICI and HDFC Bank, had a strong year in 2003 and are benefiting from important reforms in the banking sector as well as in the rise of a middle class, needy of mortgage loans. Last year the Indian parliament passed a law enabling lenders to seize and sell the assets of deadbeat borrowers to help them recoup non-performing loans. Another law allowed the formation of asset reconstruction companies to which the banks would be able to transfer their bad loans, to be repackaged and sold as pools of debt-backed securities. All of this has made Indian banks a much more interesting play for investors. Stronger economic growth also helped. Both banks’ stocks increased considerably in value in 2003.

Japanese banks (we are talking about the major institutions) are also something that investors, both for bonds and equities, have gained more investor attention, considering that they are on their way to their most profitable year in a long time. The ADR for Mitsubishi Tokyo Financial Group, for example, has more than doubled off its low earlier this year. This is not to argue that Japanese banks are without their own set of challenges. There remains considerable work to be done in dealing with the legacy of bad debts and zombie companies that still are taking bank loans but are technically bankrupt. However, the Koizumi government is making an effort to deal with the non-performing loan problem and the upswing in the Nikkei during 2003 has helped the banks’ capitalization. This was something of a worry when the Nikkei kept plunging earlier in the year.

Another interesting stock for investors has been Korea’s Hanaro Telecom. The company provides nationwide local telephone communication services and high-speed Internet services. It also offers services hosting, Internet roaming, web hosting and mail hosting services. What makes Hanaro an interesting prospect is that it emerged from financial distress in November with two large foreign owners, AIG and Newbridge, which together own close to 40% of outstanding shares. This has meant Hanaro now has an improved balance sheet, new management, operating leverage for rapid profit growth and am emerging cash flow story. For Hanaro, these positive developments were enough to capture the attention of foreign investors and lift the stock from its lows. Although the Korean telecom market is dominated by KT, Harano is the second largest broadband operator in Korea and is moving to expand market-share.

What about new triggers to send Hanaro’s stock higher? A Morgan Stanley equity report recently stated: “We believe Hanaro’s restructuring story has a strong appeal.” The report argues that for the stock (traded in Korea and via an ADR on the NASDAQ) to go higher it will have to attract Korean domestic investors. The trigger here is ”…Hanaro will have to prove it could take local telephone market share away from KT beyond market expectations.” Pending the outcome of the contest to take over Thrunet, a failed Korean Internet company, Hanaro could generate enough interest. First, it must take on LG Group, its rival, which is also seeking to purchase Thrunet. Thrunet holds 11.6% of the Korean broadband market, to Hanaro’s 24.5% and KT’s 49.8%. All of this puts Hanaro stock in play and no doubt it will be closely watched by investors, both Korean and foreign.

While the company-by-company approach is probably the best way to find worthwhile investments, one still must be aware of where Asia is heading. A more positive economic environment does not hurt anyone looking to Asia for investment possibilities. The International Monetary Fund recently stated: “Despite the slowdown since early 2003, the Asia-Pacific countries are again set to be the world’s fastest growing region this year and growth is expected to pick up further in 2004.” Japan is expected to have grown by 2% in 2003, with 1.5-1.7% growth expected for 2004, a far better trend than the previous decade of relative economic stagnation. Emerging Asia is expected to grow by 6.2% in 2004, up from the expected 5.8% in 2003. China, which has emerged as the regional locomotive of growth, is forecast to duplicate 2003’s 7.5% real GDP growth in 2004, while strong performances are expected from Thailand, Malaysia and India. Even Hong Kong, which suffered through a difficult recession over the last couple of years, is expected to gain momentum in 2004 (2.8% real GDP expansion). Singapore is also expected to rebound strongly (4.2% for 2004, compared to 0.5% for 2003). The two countries with the most uncertainty hanging over them are the Philippines and Indonesia, both of which will be holding presidential elections in 2004.

Another factor supportive of investment in Asia during 2004 is Asia’s growing self-reliance and interdependence. Although the region remains very much integrated with the global economy, regional trade and investment linkages have expanded considerably over the last 10 years. This provides some buffering from the economic cycles in North America and Europe. Along these lines, many Japanese companies have hollowed out their industrial operations in Japan and established newer ones in China, some of which export back to the island-nation as well as the United States and Europe. Japanese companies are hardly alone in this – Singaporean and Taiwanese firms have also done the same.

At the same time, the region will benefit from the U.S. economic recovery, especially in terms of export markets. Although the long-term prospects for strong growth in the United States cannot be taken for granted, through most of 2004 the North American economy will have strong enough growth to pull in Asian exports – even with a weaker dollar.

Other factors that should make Asia an attractive place for investment in 2004 include relative political stability. Despite the ongoing tensions caused by North Korea’s hermit kingdom and occasional pro-independence outbursts in Taiwan, East Asia is not marked by any wars, regime threatening rebellions, or restless military establishments. Southeast Asia does have political concerns – Islamic terrorism, upcoming presidential elections in the Philippines and Indonesia, separatist movements in Indonesia, and Burma’s harsh military junta. Yet, none of these political concerns are likely to through the region into massive turmoil in 2004.

While there is a lot to recommend playing the Asian investment card in 2004, there are potential spoilers. We see the major risks being geopolitical disruptions potentially including major radical Islamic terrorist attacks within the region targeting Americans, Europeans, Japanese and Australians, as well as North Korean and Pakistani-Indian tensions. Other potential problems include a further rise in protectionism (mainly from the United States), the potential for a slowdown in U.S. economic growth in the second half of 2004, and a higher interest rate environment (starting off in the U.S. with an earlier than expected move by the Fed to raise rates). At a more micro-level, bad earnings performances from companies could also disappointment investors.

Yes, the Asia bet is still on. We believe that companies in Asia will offer good investment opportunities for investors during 2004. To find the best returns, investors should become much like Sherlock Holmes, making a careful investigation into a number of companies, looking for clues in the form of the triggers what will make stock and bonds prices improve.