Since our last poll of investors in Asian equities the region has witnessed a desperate crisis and a surprising upturn. In the course of that cycle, a new pecking order has emerged in regional brokerage. Merrill Lynch persevered during the downturn with what is known as the British style - keeping separate sales and research operations in each country - when most US rivals chose the cheaper method of broking out of Hong Kong and Singapore hubs. Now that demand for Asian equities has returned, Merrill is the investors' favourite.
Adam Quinton, Merrill's head of Asia-Pacific equities research, recalls: "By the third quarter of 1998, the world looked like it was going to come to an end. In that quarter, the most significant thing we did was to retain commitment to our footprint strategy of being present throughout the region. At the time, we were carrying a degree of cost that was built on faith. Many other firms retrenched heavily, but coming into this year they were scrambling to get back into markets."
A feat of endurance
Although Merrill trimmed its staff last year and is now expanding again, its operation has been stable compared with those of ruthless retrenchers such as ING Barings. The Dutch-owned firm embarked on an Asian hiring spree in the summer of 1999. Deutsche Bank has also been building up its Asia-Pacific team. But those who retrench in bad times only to push for market share when activity resumes risk losing credibility in investors' eyes.
Merrill's endurance feat during the equities downturn and upturn is in contrast to its shrinkage in Asian fixed-income business, where the firm became bloated and then cut back its staff and balance sheet savagely. But then equities is not fixed-income: secondary flows provide a steadier stream of business; brokerage is less reliant on primary deals; and you don't have to carry as much inventory, thereby avoiding losses from bear markets.
In the harsh conditions of 1997 and 1998, Merrill prospered purely through the continuing volume of secondary business. Quinton observes: "One of the things that benefited us was a flight to quality." A flight, that is, to strong counterparties with the biggest local presence.
The volatile climate of Asian equities since 1997 has resulted in a shift in power - away from the regional brokers of European parentage and towards the US-owned global investment banks. In an era of high financial interdependence of regions, European-owned firms are tending to suffer from not covering the global scene. Investors want guidance on US interest rates and their likely effect on capital flows around the world. The exception to this dynamic is Warburg Dillon Read, which performs strongly in this year's poll and, like the best US performers, is both global and represented in depth in the region.
Like everyone else in the brokerage business, Warburg cut costs last year and is expanding again this year, especially in Korea and Taiwan. But as Michael Oertli, head of Asian research at Warburg, says: "We were fully committed to Asia and kept all the offices open. We also managed to maintain broad stock coverage across Asia via a good country-sector mix." Warburg was fortunate in that the integration of the old UBS and SBC led to a number of resignations and, to keep costs down, the firm simply left the gaps open until this year.
Other European firms traditionally strong in Asia include Credit Lyonnais Securities and Jardine Fleming. Credit Lyonnais in particular continues to rate highly among investors, in part for its ability to guide clients through the labyrinth of investing in China. But European firms are beginning to struggle to hold on to the best analysts. An industry insider says: "There is nobody sponsoring them during bad times. They have to manage themselves much more tightly. It's not easy to play the game as the US global houses do."
US investment banks are helped in their quest for market share by a shift in the nature of the investor base over the past two years. Consolidation among asset managers and the accumulation of money through mutual and pension funds has left US institutions like Capital International or Morgan Stanley Asset Management as the clients who count for most. Naturally, they are used to working with the US investment banks, and the European brokers will have to fight ever harder to maintain their positions.
White-knuckle ride
The picture resembles to some extent that in Japan a decade ago when the Wall Street giants began to invade the preserves of local brokers. Now only Nomura among the locals remains a real power. In pan-Asian brokerage, the firms seen by their peers as on the rise are Goldman Sachs, Morgan Stanley, CSFB, Salomon Smith Barney, and in some niches Donaldson Lufkin & Jenrette. Next year's poll will show whether investors share the brokers' view of Asia's changing balance.
In the meantime, investors who have enjoyed the comeback of Asian stock markets have to decide whether they are merely riding another rollercoaster. The brokers are eager to argue that Asia is emerging from the volatility of the past two years. Quinton at Merrill Lynch argues: "At the beginning of 1997 [before the first Asian currency crisis hit Thailand], things were not as good as they appeared. In the crises that followed, things were not as bad as they appeared. Over the long term, Asia-Pacific growth is based on strong fundamentals, including high savings and high education levels. These fundamentals are still here, though they were forgotten during 1997 and 1998."
Quinton admits that the problems of corporate governance in many countries, including over-investment and a lack of concern for returns, are by no means eradicated. Yet Warburg's Oertli argues: "Unlike in the first quarter of 1998, this market rally is based on improving fundamentals. Risks like the slow pace of financial restructuring in China and Thailand and the debt problems in Korea and Indonesia may still threaten the recovery, but robust domestic demand and the significant increase in exports are clear signals that the economies in Asia are experiencing a well-grounded rebound this year."