James Horniman, Portfolio Manager
It was a crash few people saw coming. Twenty years on from the Asia crisis, are there any lessons to be learned?
For nearly three decades from the late ‘60s, Indonesia, South Korea, Malaysia and Thailand experienced an astonishing record of economic performance – fast growth (between 5.5% and 8% pa on average), low inflation, macroeconomic stability and strong fiscal positions, high saving rates and thriving exports.
They were the Asian tigers and their shares were a key component of any global growth portfolio. But in July 1997 a crisis broke in currency markets.
It quickly transpired that the East Asian economic miracle was nothing of the sort. Huge inflows of foreign capital had created a bubble, and like all bubbles it had eventually to burst.
Weak banking systems, poor corporate governance and a lack of transparency meant the financial foundations were critically shallow. Fixed exchange rates had given borrowers – corporates and governments – a false sense of security, encouraging them to take on too much dollar-denominated debt, overstretching themselves.
The infrastructure was so obviously fragile in retrospect, but harder to see at the time.
In 1996, as exports began to weaken following the creation of the North American Free Trade Agreement and dollar strengthening, the infrastructure began to come under stress.
Floating the baht
The crisis broke in Thailand in July 1997 when it transpired that the government did not have the currency reserves to support their currency peg to the US dollar. They were given little choice but to float the Thai baht – and then watch it sink.
Markets panicked. Over the summer, currencies across the region tumbled in a series of painful devaluations – the Korean won, for instance, dropped from less than 1,000 to nearly 2,000 to the dollar in only one month. Investors and creditors scrambled for the exits.
Worst hit were Thailand, Indonesia and South Korea; China, Japan and other Asian countries also suffered, as did developed markets in Europe and the US.
Twenty years on and once more Asia is a significant part of portfolios and a powerful contributor to returns. We are overweight the region. We access Asia in two key ways – through specialist active fund managers and by investing in stocks listed on Western markets that generate much of their earnings in Asia (particularly in financial markets).
“This time it’s different” is one of the most dangerous idioms in the investor dictionary of phrase and fable. But a lot is different!
The Asian crisis led to a series of reforms – politically and economically.
There is much greater transparency; markets have matured. The growing number of Asian stocks delivering attractive dividends demonstrates corporate recognition in the region of the need to reward investors. Greater transparency and investor engagement show Western standards of governance are taking root.
A large global investment manager we met recently explained how small and mid-sized company managements in the region are actively seeking their advice in incorporating good governance practices.
There is now a strong Asian corporate debt market, offering alternatives to equity investment and additional routes to capital.
The burgeoning of domestic markets means less vulnerability to dollar fluctuations – rising wage costs in China and beyond underline how Asian economies are strengthening.
What have we learned from the Asia crisis?
The key lesson of the Asian crisis for any investor is never to fall into the trap of thinking you can see the full picture. That can lead you to be dangerously over-confident. Remember, investors were so wowed by the emerging Asian skyscrapers they forgot to check the foundations (or weren’t able to see them).
Secondly, understand that crises come from nowhere. They are usually much easier to explain afterwards than to predict. That’s why we build diversified portfolios – and include some form of insurance and protection against market shocks.
As we have said before, it’s costly to live in constant fear of a financial crisis, but it can also be expensive to ignore the possibility.