Asian markets are safe haven from credit crisis

The rapid Asian growth story has been a lucrative play for investors over the past five years. In China, where the economy has grown at an incredible average rate of 9.8 per cent a year since 2003, stock markets have almost trebled over the period, while some funds that invest in the region have delivered even better returns.

In India, which has seen average annual GDP growth of almost 8 per cent, the Bombay stock exchange has grown fivefold over the same period.

But the big question on everyone's lips over the past year is whether the booming economies of China and India – as well as some of the smaller Asian countries – can survive an economic slowdown in the West.

Although China and India have taken over as the engine of the global economy in recent years, the US is still the world's largest consumer and, some argue, its fortunes remain inextricably linked to those in Asia. Others, however, claim that domestic demand is growing quickly enough in Asia to pick up any slack if the US and Europe begin to import less. Furthermore, some observers believe that the weakening US dollar – to which many Asian currencies are pegged – will continue to keep the exports of these countries competitive.

"In our view, Asia looks a sensible risk/reward proposition," says Ian Beattie, the manager of New Star's Pacific Growth Fund. "It is less affected by the Western financial crisis. Having had its own one in 1997/98, there are, in general, much lower levels of debt in the economy and the banking system. Many of the regions' banks have more deposits than loans so are less troubled by the credit crisis – and several economies of the region have exchange rates tied to the US dollar. This puts upward pressure on them to revalue, but also means they effectively import a measure of US monetary policy. Since Ben Bernanke [the head of the US Federal Reserve] has cut interest rates very aggressively, it means that places like Hong Kong have to as well."

Nevertheless, while the arguments for economic decoupling are strong, there has been no evidence of a decoupling in the markets over the past six months, as the credit crisis has spread its roots across the developed world. Markets in the China and India are down by more than 25 per cent since the start of 2008, while the US S&P500 index has fallen less than 10 per cent over the same period. On the days that US markets have dropped significantly over the past few months, Asian markets have tended to fall faster and further.

But David Orr, the product director at Fidelity International, is unfazed, claiming the economic story will eventually play through. "I think Asia still has the best growth prospects of any region in the world, and therefore companies in the region have a good ability to deliver strong earnings growth," he says.

"Over the next two years, consensus economic forecasts are that Asia will deliver healthy, consistent GDP growth, even as other parts of the world slow... more than double the growth rates of the US, Europe and Japan. There is a clear correlation between GDP growth rates and expected earnings per share. Even those markets in the region where GDP growth is slower, such as Australia, are still seeing [estimated] healthy double-digit earnings growth rates.

"There may be periods where investors are nervous, but the market outlook for GDP growth, earnings growth and valuations is not extreme. So, although there will be volatility in the short-term, companies in the Asia Pacific region should still be able to deliver double-digit returns."

Orr says it is not just China and India that investors should be looking at. Investors in Australia, Pakistan and Indonesia have enjoyed strong returns recently, and look able to continue that growth.

Beattie agrees, picking out stocks such as Thai property company Preuksa and Australian energy group Santos as two of his favourite holdings outside of China and India. In China itself, Beattie says he likes Shenzhen Investment, a property company which is trading at a big discount to the value of its assets.

Investing in Asia should not be confused with investing in Japan, which is a much more developed market, and is usually excluded from Asia Pacific investment funds.

Remarkably, Japan has spent most of the past 20 years recovering from the bursting of its property bubble and, today, the market still sits at about two-thirds below its peak in the late 1980s. Furthermore, unlike its Asian peers, its population is shrinking, which does not bode well for the country's long-term investment prospects.

Nevertheless, those who specialise in the region believe that after the underperformance in markets over much of the past two decades, there is a fantastic medium-term investment story in Japan, making it well worth considering for a slot in your portfolio.

"There's a difficult backdrop for all markets at the moment," Simon Somerville, manager of Fidelity's Japan fund, says. "But the Japanese market is cheap. Something like 50 per cent of companies are trading below their book value." In simple terms, that means that if you closed down every company in Japan and sold off its parts, more than half of the businesses would be worth more than their current market value.

Unfortunately, however, markets can undervalue companies for long periods of time – and there is no guarantee that a turnaround is imminent. At least 10 per cent of Japanese businesses depend on the global economy, and will suffer from the downturn in the US. This week alone, Toshiba and Sony Ericsson both issued profits warnings.

But Somerville believes there is money to be made in companies that are more domestically focused. "My largest holding is NTT DoCoMo, Japan's largest mobile phone provider," he says. East Japan Railway is another major holding.

Somerville admits that the political situation has been delicate in Japan, pointing out that there has been "a paralysis of policy" since the ruling party lost control of the upper chamber last summer. However, he is hopeful that this period is coming to an end, and may be followed by a time of political change and reform in Japan.

Although time was that financial advisers would recommend Japan as a core holding, Somerville says the long-term prospects are no longer exciting. However, for the medium term – especially at a time when other developed markets are suffering from the credit crunch – Japan offers good prospects for investors.

How to invest in the Far East

Investing directly in Asian equities is a risky, not to mention complicated, pursuit for the average investor. A far easier way to get exposure to the region is by investing in mutual funds, where a professional manager will do the stock picking for you.

Mick Gilligan, the director of fund research at Killik stockbrokers, says that First State's Asia Pacific fund is one of his favourites – a fund that has almost trebled investors' money over the past five years. For investors looking for a more focused investment, he recommends China Real Estate Opportunities, managed by Treasury Holdings, as he believes property will be one of the key asset classes in the region over the coming years.

For those interested in taking the plunge into Japan, Brian Dennehy of Dennehy Weller, the financial advisers, picks out Axa Framlington's Japan fund.

Dennehy admits that very few clients have been interested in the region in recent months, but says he believes there is now a unique investment opportunity, particularly among smaller companies.

For those with a higher appetite for risk, he suggests investing in M&G's Japan Smaller Companies or Invesco Perpetual's Japanese Smaller Companies funds. While investment performance in these funds has been poor in recent years, he believes they are now on the verge of coming into their own.

Barclays Stockbrokers says that its biggest selling Asian fund of 2007 was Gartmore's China Opportunities. This has returned an incredible 262 per cent over the past five years. However, investors should be careful about paying too much attention to past performance. Aberdeen's Asia Pacific fund was second best.