OCBC Taiwan Fund

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OCBC TAIWAN FUND

Since the tech bubble burst in 2000, the tech laden Taiwan stock index, the TSEC, has been largely posting negative returns. The exception however was in 2003, when the index returned 32.13% for the year. That negative trend appears to have turned once again in recent months. For example, in the 3-month and 6-month period ending 28 February 2005 the index returned 9.11% and 12.06% respectively (in SGD terms; sourced from Bloomberg).

According to OCBC Taiwan fund manager Tan Hoe Heng, the equity market could be near a turning point. He says that a lot of bad news has already been factored in, and the market now trades at a discount of around 12 times PE. However, he adds the caveat that with a market as volatile as Taiwan, it's very hard to accurately catch the bottom. The market is still very much driven by volatile tech stocks. "Its always hard to call the bottom of the technology cycle, because by the time you realize its the bottom, stock prices would have moved up 50%".

The OCBC Taiwan Fund aims for medium to long term capital appreciation by investing in Taiwan equities and equity-related instruments. The Fund, denominated in SGD, will not target any specific industry or sector. The fund's performance is quite closely correlated to the benchmark (refer to chart below). As at end February 2005, the Fund's heaviest weighting is in technology and industrial stocks. Together, they constitute over 60% of the fund (see sector allocation).

SOURCE: FUNDSUPERMART, BLOOMBERG

SOURCE: FUNDSUPERMART

Tan says that foreign investor participation has increased over the past couple of years, but is still low compared to other markets in Asia such as Singapore. That's because Taiwan stocks used to trade at an average of 30X PE, which was considered expensive by foreign investors. After the bursting of the tech bubble in 2000, he notes that valuations have been gradually coming off, and the Taiwanese market now trades at similar valuations to other markets in the region.

As a result, he says that foreign investors are starting take more notice. Furthermore, many Asian markets have already appreciated substantially. Having performed quite poorly last year, it is possible that the Taiwanese market will draw more attention this year.

Stock Market Trends

The fund manager says that with the shortening of product cycles in the global technology sector, Taiwanese companies have benefited from an increase in outsourcing. "I think all the product makers have realized that the fastest way to do it is by outsourcing. That is where the Taiwanese have benefited." Tan adds that they are making use of this development to improve on their services. "They are starting to help out tech companies (or clients) in product design. Basically what happens is very simple. Let's say Motorola designs 20 handsets a year and then the Taiwanese can design another 10 handsets. So Motorola can push out 30 instead of 20 handsets in that year. Like for example O2 phones, it is basically a Taiwanese design and manufacture as well. About 15-20% of handsets are being outsourced to the Taiwanese in this way. So there is still a lot of room for outsourcing growth."

Besides technology and industrial stocks, the Taiwan equity market is also driven by sectors such chemical, steel and petrochemicals, although to a much lesser extent. Tan says the fortunes of these sectors will be influenced by the global economy.

The basic materials industry constitutes a significant part of the equity market. Basic materials refers to commodities such as gold, chemicals, paper etc and commodity related products. Examples of basic material stocks in the fund include China Steel, and Formosa Chemical and Fibre. The fund house is positive on the outlook for this sector and believes that the high prices that were established last year will continue to remain. "I think earlier on, a lot of people are looking at all these prices to peak and to drop this year. Investors will think since the stock market is forward looking and is peaking this year, so better sell the stock. So that's why the basic materials prices have dropped, and the stocks have corrected. Our houseview is that we believe that the global cycle after turning soft a bit for the last one or two quarters, is going to re-accelerate a a bit. Global growth is likely going to surprise investors in a positive way. It will be good for the tech and the basic materials industry, which is why we believe that we should ignore some of the political noise and maintaining a longer term view."

Dividend Plays & Large Caps Feature Strongly In The Fund

An important part of the investment strategy for the fund is to invest in established companies that pay good dividends. Tan says that dividend yields indicate the financial strength of the company. "We do not want a company that keeps on coming back to the shareholder for money to invest. We want a company that can reward shareholders in the long term. The fact that the company is able to pay out good dividends shows that it has strong cash flow and has enough left for reinvestment for its growth. And I think also given the uncertainty in the market at this point in time, at least dividend yield is something that will give you some returns if you don't have capital appreciation."

Majority of the fund allocation is currently in large capitalization stocks. At the moment, the fund manager says they are more attractively valued than small cap stocks. "The valuations have come down quite significantly. And a lot of them being the large players, we believe the large companies will get larger because of their critical mass. There is certain advantage they have in terms of economies of scale. And the fact that they are not trading at more expensive valuations relative to the smaller and mid caps, considering that they have strong management and economies of scale, makes us want to buy them."

RISKS

Tan does acknowledge that investing in the Taiwanese market does come with several risks. These include:

• Volatility
• Political risks
• Influence on stock market by domestic investor sentiment
• Uncertainty of timing of technology recovery
• Risk of poorer than expected recovery

Tan notes that poltical risk is usually centred on Taiwan's delicate and often troubled relations with China. China considers Taiwan a renegede province, and opposes any moves towards Taiwan declaring its independence. In the past, China has even threatened military retaliation. Tan says such "political noise" will definitely affect stock prices, but mostly for the short term.

Another key risk for the market says Tan, is the uncertainty over the recovery in the technology sector. "People know that the recovery is near, but the timing is of great uncertainty. The upside may or may not be dramatic in the near term, despite the earlier correction. But we believe that the fundamentals for the market are good."

WHERE DOES THIS FUND BELONG IN AN INVESTMENT PORTFOLIO?

The OCBC Taiwan Fund can be part of the supplementary portfolio for the long term investor (click here to read about our core and supplementary portfolio). That's because single country equity funds are considered high risk (with a Fundsupermart risk rating of 10; click here to view our risk rating system) and have higher volatility than bond funds or regional equity funds. Though volatile, they can also achieve very high returns, for example rising by more than 40% in a year. That is why we encourage investors to diversify accordingly (click here to read an article on the importance of diversification)

The pie chart above illustrates where single country funds (the dark blue portion) belong in an overall portfolio. The percentage which should be allocated to global bond funds is dependent on an individual's risk profile. The diagram shows the asset allocation for a balanced investor, and may not reflect an individual's risk/return profile. (To view investment portfolios tailored for different risk profiles, click here for our Fundsupermart Recommended portfolios).