One sweeping observation can safely be made about investing in Asia Asian companies have a problem with disclosure. No incident did more to highlight this than the Tsingtao debacle two years ago. In April 1995, investors learnt that Tsingtao, China’s biggest brewery and the best known of the “H” shares (mainland firms listed in Hong Kong), had not, as its prospectus had promised, used $114 million raised during its 1993 flotation to expand capacity. Rather, it had loaned most of the money via banks to other Chinese firms. Tsingtao was apparently better at picking pockets than picking winners: its 1994 net profits fell 42%.
Tsingtao is a particularly egregious example of a problem apparent in markets from Bombay to Bangkok. Investors in Asian equities have learnt the hard way that the stocks they purchase often bear little resemblance to the stories they are sold. This is by no means unique to Asia, and, as the markets mature, disclosure will no doubt improve. But it might improve sooner, critics say, were brokers’ research better. “It’s easy to say there is a culture of inadequate or even false disclosure,” says Anthony Miller, president of Asian Investment Partners in Hong Kong. “But blaming this for the lack of information just tells me that research departments aren’t doing their jobs.”
Over the Chinese wall
Throughout the region, a similar complaint is voiced: the analysts are too young, inexperienced, and insufficiently cynical. As a result, their coverage often borders on the useless. The research in Asia is demonstrably worse than research in New York and London. But the real problem isn’t quality, it’s objectivity. Like many of their colleagues elsewhere, analysts in Asia are increasingly being dragged over the Chinese wall in order to help sell corporate finance deals.
There are several reasons why Asia, more than most regions, needs unbiased research. In North America and Europe, the regulatory framework generally ensures a high degree of transparency. In Asia, by contrast, the rules seem constantly to be trying to catch up with the infractions. Accounting standards, which vary greatly from market to market, are also inadequate in the view of many investors. Then there is the corporate culture itself. Deals are often cut behind closed doors and many firms, particularly family-owned ones, plan to keep it that way.
Even a company as closely watched as Gordon Wu’s Hong Kong-based Hopewell Holdings is something of a mystery to outsiders. “Can you understand Hopewell’s balance sheet?” asks one investment banker. “I am sure that no-one can adequately analyze that firm.” Worse still are the region’s powerful conglomerates, which bring their opaque methods to a dizzying array of industries. It was hardly a shock, then, when the US-based Centre for Financial Research and Analysis found in its most recent survey that four Asian nations were among the 10 countries with weakest disclosure and the study didn’t even include China and Indonesia.
Governments in Asia can be just as evasive as companies. Economic data are famously unreliable in many parts of the region, and analysts who pry too much can end up on the wrong side of the law. Last October, an SBC Warburg employee in Beijing was detained for a month without charge after allegations that she had stolen state secrets a central bank report. A Singapore economist for Crosby Securities faced similar charges several years earlier after getting hold of data that was still embargoed. Nor is criticism always well received: in 1995, Thai officials lashed out at Crédit Lyonnais economist Jim Walker, who had warned investors that Thailand was becoming over-reliant on short-term capital inflows.
In the face of these obstacles, analysts are the first, and often last, line of defence for global investors. What’s wrong with the Asian research that’s published? “The quality of the paper is very high,” quips Marc Faber, a Hong Kong-based investment expert who runs his own firm. “The colours are very bright and the reports are very heavy. It’s what’s inside that is a problem.” Even the essentials can be unreliable: one fund manager says it’s not uncommon to pick up several reports on the same firm, only to find that each one lists a different number of shares in issue. Subjective material is seldom any better. “Most of the research doesn’t look past its nose,” admits one analyst. Sometimes, it doesn’t even look that far.
Take, for instance, a report on Hong Kong-based toy development and marketing group Playmates Toys that was issued last August by one of Asia’s leading brokerage firms. It was 15 pages of the most superficial analysis imaginable; more information would almost surely have been gleaned from Playmates’ annual report or even a story in the South China Morning Post. The analyst judged Playmates a buy. His rationale: after an abysmal 1995 the company was poised for a strong recovery if a new line of toys based on the film Space Jam, starring Michael Jordan and several famous cartoon characters, proved as popular as the firm’s line of Teenage Mutant Ninja Turtles toys.
On page four of the report, readers are advised: “Earnings can really kick in should ‘Space Jams’ be half as successful as ‘Turtles.'” On page eight, they are told, “If the film ‘Space Jam’ this Christmas turns out to be a hit, there should be an upward revision in earnings.” On page 10, they are assured that “earnings can really kick in should they find a line half as successful as ‘Ninja Turtles'”. And if that wasn’t enough to sell readers on the stock, perhaps this was: “A marketing team is located in the US to monitor any upcoming opportunities in Hollywood.” Playmates isn’t a big firm its market capitalization is US$150 million and it’s clearly in no danger of making anyone’s Hong Kong A-list. All the same, its shares are traded on a major exchange; it deserves more scrutiny than this.
More often than not the research is done by twenty-somethings with minimal experience and limited skills. This isn’t the case in every market Hong Kong and Singapore have plenty of top-notch analysts but it is true enough for many of them. Good analysts are rare in Malaysia and Thailand and even harder to find in the Philippines and Indonesia. “In Indonesia, there’s such a thin level of talent on the ground that we decided to just step back,” says a Hong Kong-based research director.
Bandwagon mentality
The dearth of experience breeds lemming-like behaviour. An American analyst in Hong Kong says many of his colleagues wait to read what others have to say about a company before writing their own reports. Although this certainly isn’t exclusive to Asia, it seems to have its most profound impact there. “There is a bandwagon mentality out here,” says another US-trained analyst. “For a young analyst with maybe a year’s experience, it’s very tough to stick your neck out and go against the prevailing wisdom.”
The research also suffers because many analysts see their work as simply a stepping stone to a lucrative job on the buy side rather than a permanent career path that may lead to wider media exposure. “In New York, you find Mr XYZ, the doyen of the cosmetics sector, with a CNN-type reputation,” says a Singapore-based money manager. “Here, the concept of being an analyst for life hasn’t caught on.” The head of research for a leading Kuala Lumpur broker-dealer found this out first-hand last summer while trying to fill a vacancy. “I interviewed 50 people for the job and asked them what they expected to be doing in five years,” he recalls. “Exactly one said he expected to still be an analyst. Needless to say, he got the job straightaway.”
Chances are he got a big pay rise, too. Faced with a mediocre pool of talent in Asia, the region’s investment houses have reacted in typically perverse fashion: they have bid the market through the roof. In the past year or so there has been an unprecedented amount of poaching and job-hopping as brokers seek to bolster their presence in the region. Analysts who wouldn’t merit a second look in London have been able to double, even triple, their salaries simply by changing seats a lot. One Hong Kong banking analyst spent eight months with Crosby, nine months at Crédit Lyonnais, then agreed to join Merrill Lynch but reneged on the deal when Lehman Brothers came along with an even better offer.
The current recruitment battle is actually a less costly version of what took place three years ago. Then, several bulge-bracket American houses poured vast resources into Asia but soon discovered there wasn’t enough business to justify the cost of keeping a large expatriate staff in Hong Kong and other hubs. In little more than a year, those same firms were beating a hasty retreat. Eager to strengthen operations in the region but determined to avoid repeating that mistake, most firms are now focusing on hiring local personnel.
However, when it comes to expanding their research capabilities, they’ve learnt the lessons of the recent past perhaps too well. It’s clear that many houses are failing to provide their recruits with the training and advice needed to make them quality analysts. “There really isn’t anyone for these kids to learn from,” says an American analyst based in Hong Kong. Asian Investment Partner’s Miller agrees. He believes investment banks should bring their best and brightest analysts to Asia but admits it won’t be easy. “They are making far more money at home, so there isn’t a rush to Asia,” he says. “You have to create incentives for people to want to be out here.”
One big disincentive is the fact that analysts in Asia are increasingly being pressured by their firms’ corporate finance departments. They aren’t asking companies tough questions because their bosses often don’t want them to. This is the real problem with research in Asia. A decade ago, when the focus was primarily on secondary-market research, analysts were generally given a wide berth. That’s no longer the case. In their effort to win mandates, investment banks are determined above all not to ruffle feathers in corporate boardrooms and the corridors of power. “The conflicts of interest are just huge,” says Bill Kaye, who runs the Hong Kong-based Asian Hedge Fund.
Seldom if ever are those conflicts resolved in favour of the research departments. Last year, an analyst at Kleinwort Benson put his firm in hot water by calling Malaysia’s economic policies “noddynomics”. Kleinwort officials quickly had the paper recalled and apologized to the Malaysian government. David Roche, who now heads his own London-based research boutique, Independent Strategy, has said that many of his biggest fights at Morgan Stanley, where he was chief strategist until 1994, concerned Asia. He says one of the incidents that encouraged him to leave was a plan to have his China reports reviewed by the Hong Kong office, which had apparently found them too critical of Beijing.
Any lingering doubts about Morgan Stanley’s priorities were firmly put to rest when it established a joint venture with China International Capital Corporation (CICC), the mainland’s first bona fide investment bank, soon after Roche quit. But if Morgan Stanley has compromised its coverage in order to gain a toehold on the mainland, it’s hardly the only house to do so. Kaye feels that investment banks have been less than forthright about most of the “H” shares brought to market: “These companies are horrible. Why was the industry not pointing out clear deficiencies? How many firms have written a single candid piece about China?”
Hypocrisy
The desire to soft-pedal problems in China seems certain to grow after Hong Kong is restored to mainland rule on July 1. Faber and others are predicting an avalanche of Chinese listings on the Hong Kong exchange after the handover. Although the calibre of firm is not likely to be any better than before, and could well be worse, that probably won’t deter many investment banks. Nor is the indiscriminate deal-making limited to China. One Hong Kong research head, whose department seems to be one of the few in Asia that enjoys a veto over the corporate finance side, says his analysts have rejected scores of deals in southeast Asia, only to see other houses pick them up.
In fairness to the investment banks and analysts, there is an element of hypocrisy in fund managers’ griping. Although most institutional investors claim they never make picks based on recommendations, they get angry when the research they use fails to lead them to what they are looking for. “A lot of money managers are sort of flailing around, waiting for the next hot story,” notes Jeff Uscher, the editor of Grant’s Asia Observer. “When that story doesn’t materialize, they take it out on analysts. If they weren’t looking for the next hot story, they would probably find an investment.”
Moreover, those on the buy side are usually just as young, inexperienced and gullible as the people feeding them information. “It’s the one-eyed person leading the blind,” says Faber. And while investors demand better-quality research, they also want it at cut-rate prices; given a choice, most of them prefer to pay lower commissions than to pay a bit extra for improved analysis. Since the research department is a cost centre for most brokerage firms, the steady downward pressure on transaction fees gives them even less reason to boost their coverage. In other words, investors get what they pay for.
Buy-side research
Some investors have decided that quality research is worth paying for. Roche’s firm has met with a much more favourable response than expected, proof, Roche thinks, that investors were starved of unbiased, comprehensive analysis. Specialized research on Asia could have a bright future if the region’s brokers continue to perform inadequately. Some big institutional investors have already taken matters into their own hands. GE Capital and Fidelity, for example, employ nearly as many analysts in Asia as some leading brokers. Several big hedge funds, including Quantum, have also put research staff on the ground.
This doesn’t mean brokerage research is becoming obsolescent. Despite the in-house pressures they face, many research departments are struggling to keep their work relevant to investors. “The days of easy research, of popping into a place and not taking into account what’s happening throughout Asia and elsewhere, are over,” says Edmund Bradley, who manages Asian research for Crédit Lyonnais. Indeed in the past few years the matrix approach which marries sectoral coverage to market-specific analysis has nudged aside the maintenance research model, a company-specific, country-specific method popularized by the British houses.
Any approach that combines industry expertise and local knowledge has a logic and value that’s hard to quarrel with. But there is a feeling, at least among some fund managers, that brokers are a bit too keen to emphasize their sectoral coverage. The approach has unquestionable appeal, not least because it’s cheaper, enabling firms to give blanket coverage to the entire region from a single hub rather than having to set up shop in every major city. It also gives analysts more opportunity to make names for themselves nearly all the star analysts are sectoral specialists.
But as Bradley points out, there are not that many industries that are fundamentally affected by global trends. And while these clearly do matter in Asia local conditions are more important. One Singapore fund manager argues that brokers would do well to stay focused on the markets, where some basic questions still need to be addressed. “I would like to see research that tries to make up for the lack of market valuation measures,” he says. “We don’t have bond markets, bond yields, long-dated bonds. We have no way of looking at risk-free rates of return, equity risk premiums and other tools that are the staple diet of strategists. How do you value companies and markets here? What’s needed are alternative benchmarks. That sort of research would be of some value.”
There is more demand than ever for quality research on Asian economies and Asian companies. Ten years from now, many of the problems plaguing the region’s analysts will have been solved. The acute need for capital, coupled with tighter regulation, will have forced on Asian corporates a degree of transparency presently unimaginable. But brokers and investment banks could hasten these developments if they were to provide investors with the objective research they seek.
