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Baring Asset Management (Asia) Limited 19th Floor, Edinburgh Tower 15 Queen’s Road Central, Hong Kong Tel: (852) 2841 1411 Fax: (852) 2868 5296 Internet: www.baring-asset.com THE ASIA PACIFIC FUND, INC. Virtual Forum 2006 : Outlook for Asia Pacific Markets Khiem Do – Head of Asian Equities April 2006 BAM’s 2006 Key Global Forecasts G7 economies expected to grow at long-term trend rates, with first half stronger than second half G7 core inflation likely to remain below 2% US Federal Reserve likely to pause when rates reach 5% by June ’06, and ECB / BoJ to tighten gradually USD likely to reach a peak in H1 ’06 Oil prices likely to range trade between $US 55-70 /bbl Still a relatively benign global backdrop, but G3 monetary policy direction is key 1 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt BAM’S 2006 Key Asia Pacific Forecasts China expected to continue to grow solidly (9 – 9.5%) and drive the region Recovery of Japan is an added bonus Other Asian economies to grow at long-term trend rates Asia Pacific central banks expected to tighten slightly, but unlikely to strictly follow the US Fed (domestic conditions matter more) Asia Pacific currencies likely to strengthen modestly vs the USD A favourable economic backdrop for the region 2 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Out-performance of Asia A Secular Re-rating Has Started A treacherous history but underperformance ended in 1998 MSCI Asia ex-Japan relative to MSCI World MSCI Asia ex-Japan relative to MSCI USA 2005 2003 2001 1999 1997 1995 1993 1989 01/06 01/05 01/04 01/03 (80) 01/02 0 01/01 (60) 01/00 50 01/99 (40) 01/98 100 01/97 (20) 01/96 150 01/95 0 01/94 200 01/93 20 01/92 250 01/91 40 01/90 300 01/89 60 01/88 350 1991 Asia outperformed over the last five years MSCI Asia ex-Japan return differential over MSCI World MSCI Asia ex-Japan return differential over MSCI USA Source : HSBC (3/2006) 3 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Asia’s out-performance is set to continue Convergence of Valuation of equity markets 30 1.8 MSCI Korea forward P/E (LHS) MSCI AC World forward P/E (LHS) 1.6 Relative P/E (Korea/World) (RHS) 25 1.4 20 1.2 1.0 15 0.8 10 0.6 0.4 5 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 Jan-92 Jan-91 0 0.2 0.0 Source: Goldman Sachs (1/2006) Koran P/E re-rated, global P/E de-rated 4 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt 5 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Far East Asia appears cheap vs India and other Emerging Markets Jan-06 Sep-05 8 May-05 5 Jan-05 10 Sep-04 10 May-04 15 Jan-04 20 Sep-03 PE May-03 25 Jan-06 Sep-05 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 MSCI China Jan-03 MSCI Korea Sep-02 30 May-02 10 May-02 5 Jan-02 12 Jan-02 10 Sep-01 15 Sep-01 20 May-01 25 May-01 PE Jan-01 Jan-06 Sep-05 40 Jan-01 Jan-06 Sep-05 30 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 35 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Far East Asia: Absolute PER remains low MSCI India 22 20 18 16 14 PE MSCI EM ex-Asia 20 18 16 14 12 PE Source : UBS (3/2006) Japan: Property Prices are recovering Land prices rising after 14 years And recovering beyond Tokyo (index, 1985=100) HoH, % 10 5 Office rents in Tokyo rising Tokyo Metropolitan Wards (Highest priced lots) 6 Largest Cities (Highest priced lots) Tokyo Metropolitan Wards (Average) 0 280 260 240 220 200 -5 180 -10 160 140 -15 120 -20 100 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 Note: Six largest cities include Tokyo, Yokohama, Nagoya, Kyoto, Osaka and Kobe; as at September 2005 Source: Japan Real Estate Institute, INDB, compiled by Goldman Sachs Research, as at September 2005 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 Note: Office rents for new buildings in the Tokyo Metropolitan area; half-year basis, as at 1H2005. Source: Nikkei, compiled by Goldman Sachs Research, as at June 2005 Positive for Japanese consumers and Asian exports 6 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt China : Overheating has been addressed FAI Growth CPI Growth %YoY %YoY 30 30 25 25 20 20 15 15 10 10 5 5 0 0 95 96 97 98 99 00 01 02 03 04 05 -5 94 95 96 98 99 00 01 02 03 04 05 Industrial Production Output Growth Loan Growth %YoY %YoY 25 97 18 16 14 20 12 15 10 8 10 6 4 5 2 0 0 99 00 01 02 03 04 05 95 96 97 98 99 00 01 02 03 04 05 Source: UBS (3/2006) 7 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Still in “goldilocks” phase (strong growth, low inflation) China : Domestic Consumption is under-estimated, under-appreciated GDP Breakdown by Output Revision 15% Agriculture Industrial Construction 53% +1% 13% +2% 46% Service Industry 32% Before revision (2004) 41% +49% After revision (2004) Source: BNP Paribas (02/2006) China GDP in 2004 was revised up by 16.8% Service industry is a bigger pie to GDP composition than initially thought 8 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt China is under-going an Industrialisation phase, just like Japan and Korea did FAI as % of GDP - Japan FAI as % of GDP - China % % 40 40 38 36 34 35 32 30 30 28 26 24 22 20 25 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 20 1990 FAI as % of GDP - Korea % 1993 1996 1999 2002 2005E 45 40 35 30 25 Both Korea and Japan had FAI as % of GDP in the range of 30 – 40% lasting for one to two decades → China expected to grow solidly over next 5 years 20 15 75 77 79 81 83 85 87 89 91 93 95 Source: Goldman Sachs (02/2006) 9 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt China: Rural Income Growth accelerates, finally ! Urban income growth Rural Income Growth (% YoY) (% YoY) 14 14 12 12 10 10 8 8 6 6 4 0 4 Per capital income - urban 2 2 0 2001 2002 2003 Per capita income - rural 2004 2001 2002 2003 2004 Source: CEIC, CLSA (12/2005) Thanks to supportive policies from the government Pick up of rural income growth a further boost to domestic consumption Rural population → 70% of China population 10 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Health of Chinese Banking system has been improving NPL Ratio Trend Net Interest Margin 20% 2.9% 18% 2.8% 16% Net interest margin 14% 2.7% 12% 10% 2.6% 8% 2.5% 6% 4% 2.4% 2% 2.3% Improving net interest margin Falling NPL ratio Source: Lehman (02/2006) 11 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt “Cleaned-up” Chinese banks: unrecognised growth stocks? Dec-05 Oct-05 Aug-05 Jun-05 Apr-05 Feb-05 Dec-04 Oct-04 20051H Aug-04 2004 Jun-04 2003 Apr-04 2002 Feb-04 2.2% Dec-03 0% Momentum Factor Out-performed significantly since mid-2005 Representative Pacific Portfolio Market Return VaR Factor Exposures, last 18 months (as at 28th February 2006) Cumulative Factor Returns, last 18 months (as at 28th February 2006) 20% 0.60 0.50 15% 0.40 0.30 10% 0.20 5% 0.10 0.00 0% -0.10 -0.20 Aug 2004 Nov 2004 Value Feb 2005 Growth May 2005 Size Aug 2005 Momentum Nov 2005 Feb 2006 -5% Aug 2004 Nov 2004 Feb 2005 Value May 2005 Growth Aug 2005 Size Nov 2005 Feb 2006 Momentum Source: Baring Asset Management Investors have been chasing strong and sustainable earnings and price momentum 12 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Global Risk Appetite: In “high zone” currently 10 Euphoria 8 6 4 2 0 -2 -4 Panic -6 Jan-81 Jan-84 Jan-87 Jan-90 Panic Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Source: CSFB (27/2/2006) Investors appear to want to continue to buy high beta growth assets → our research focus is directed towards defensive growth 13 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Concluding Remarks Asia Pacific economies and markets are expected to continue to out-perform the world in 2006 As equity risk premium is deemed to be too low, our team continues to build a more defensive growth bias in your portfolio Favoured Themes include: domestic reflation plays in Korea and China, Taiwanese technology, ASEAN consumption and financials, and materials Research focus on defensive growth and “un-loved” high-yielding names, in preparation for a potentially more challenging second half 14 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Individual Asian Markets : Outlook & Strategy Change of Market Leadership from Korea/Taiwan to China from end 2005 135 FTSE Pacific ex-Japan 130 125 120 115 110 105 100 95 90 03/05 06/05 FT Korea 09/05 FT Taiwan Technology 12/05 03/06 MSCI China Source: Factset (6/3/2006) China’s out-performance is expected to continue 16 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Korea and India Re-rated in 2005 on rise of ROE MSCI Korea MSCI India 2.1 19% 5.0 23% 1.9 17% 4.5 22% 11% 1.1 9% PB 13% 1.3 20% 3.5 ROE 19% 3.0 18% 2.5 17% ROE PB 01/06 01/06 07/05 01/05 07/04 01/04 07/03 01/03 07/02 01/02 07/01 01/01 PB 07/05 14% 01/05 1.0 07/04 5% 01/04 0.5 07/03 15% 01/03 1.5 07/02 0.7 01/02 16% 7% 07/01 2.0 0.9 01/01 PB 1.5 21% 4.0 15% ROE Source : UBS (3/2006) Further re-rating in Korea vs India expected 17 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt ROE 1.7 Korean Market: Different this time ? KOSPI near all-time high, but current PE is well below historical peaks PE= 10.5x 1,600 1,400 Now PE= 9.5x PE= 17.2x PE= 14.1x 1,200 PE= 18.8x 1,000 800 600 400 200 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 KOSPI Weekly Source: UBS (3/2006) Valuations still not stretched 18 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt China Re-rating has just started 3.5 18% 17% 16% 15% 14% 13% 12% 11% 10% 9% 8% 3.0 PB 2.5 2.0 1.5 PB Jan-06 Sep-05 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 1.0 ROE MSCI China ROE Source : UBS (3/2006) China appears grossly undervalued 19 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Asia Pacific : Relative valuation of markets P/BV less ROE relative to Asia ex Japan currently 40% overvalued 30% 20% 10% 0% -10% -20% undervalued -30% India Singapore Australia Malaysia Hong Kong Phil Taiwan Indonesia China Korea Thailand -40% Source: UBS (3/2006) Underweighting the expensive and overweighting the cheap markets 20 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Asia Pacific : Relative valuation of sectors P/BV relative less ROE relative currently 80% 60% 40% 20% 0% -20% -40% -60% Con non cyclical Tech Industrial Con cyclical Financial Utilities Telcos Energy Basic materials -80% Source: UBS (3/2006) Underweighting the expensive and overweighting the cheap sectors 21 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Hong Kong/China: Overweight Overweight China and underweight Hong Kong Solid economic growth in China (9 – 9.5%) expected to continue HK economy and property sector being negatively impacted by US monetary tightening mid-cycle correction HK market expected to perform better when US Fed pauses Focus on domestic reflation plays (banks, insurance, property), materials and consumer in China 22 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Korea: Slight Overweight Market still relatively cheap and should be further rerated, but ..... Interest rates likely to rise further Earnings likely to be downgraded due to strong Won Looking to add exposure at lower levels 23 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Taiwan: Slight Underweight Still no new development on the Cross-Straits link issue Low participation of retail investors does not bode well for the market Technology still the key driver of stock market Market valuation is moderately cheap 24 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Singapore: Slight Overweight Steady economic growth expected Reflationary policy endorsed Corporate re-structuring trend still unfolding Market valuation at fair levels 25 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Emerging ASEAN: Underweight Thailand is the preferred Emerging ASEAN market (low valuation, poor sentiment) Look to add to Indonesia on weakness Specific stock opportunities in Malaysia and Philippines, as macro environment is deemed uninspiring 26 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt India: Look to build up a larger exposure on weakness Growth is strong, but rise in inflation, interest rates and current account trends is causing concerns, and ……… Valuations are expensive (2005 P/E = 17.6X earnings vs Asia of 13.3X; P/B = 3.6X vs 1.9X respectively) Source: Morgan Stanley, 3/2006 On weakness, we look to add to build a larger exposure 27 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt Important Information This document is provided as a service to professional investors/advisers. It is issued in the United Kingdom by Baring Asset Management Limited and/or by its investment adviser affiliates in other jurisdictions. The affiliate serving as the Asia Pacific Fund’s investment adviser is Baring Asset Management (Asia) Limited. In the United Kingdom this document is issued only to persons falling within a permitted category under (i) the FSA’s rules made under section 238(5) of the Financial Services and Markets Act 2000 and (ii) the Financial Services and Markets Act 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001. This is not an offer nor a solicitation to buy or sell any investment referred to in this document. Baring Asset Management group companies, their affiliates and/or their directors, officers and employees may own or have positions in any investment mentioned herein or any investment related thereto and from time to time add to or dispose of any such investment. The contents of this document are based upon sources of information believed to be reliable but no guarantee, warranty or representation, express or implied, is given as to their accuracy or completeness. This document may include forward-looking statements, which are based upon our current opinions, expectations and projections as of the date on the cover hereof. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. Changes in rates of exchange may have an adverse effect on the value, price or income of an investment. There are additional risks associated with investments (made directly or through investment vehicles which invest) in emerging or developing markets. Compensation arrangements under the Financial Services and Markets Act 2000 of the United Kingdom will not be available. Private investors in the Company referred to herein should obtain their own independent financial advise before making investments. This document must not be relied on for purposes of any investment decisions. Before investing in the Company, we recommend that all relevant documents, such as reports and accounts and prospectus should be read, which specify the particular risks associated with investment in the Company, together with any specific restrictions applying and the basis of dealing. The Company may not be available for investment in all jurisdictions. There may also be prohibitions or restrictions on distribution of this document and other material relating to the Company and accordingly recipients of any such documents are advised to inform themselves about and to observe any such restrictions. Complied (Boston): March 18, 2006 28 (HK: s:\shared\investmentmanagement\accounts\tango\present\0604-Virtual Form.ppt