The DBS Malaysia Equity Fund* aims to achieve medium to long-term capital appreciation by investing mainly in Malaysian equities that are listed on the recognised stock exchanges in Malaysia (in particular the Kuala Lumpur Stock Exchange and the MESDAQ). This fund closely mirrors the Hwang-DBS Select Opportunity Fund, and combines active asset allocation and sector/theme selection. According to fund manager Teng Chee Wai**, the fund's investment style is a combination of value and growth strategies, but with a core emphasis on investing in companies that have a good business model, competent management, excellent earnings and bright growth prospects. In this interview, he explains the key drivers for the Malaysian equity market and why there's further upside potential.

Q: Are valuations attractive for the equity market vis-a-vis other Asia ex-Japan markets? Is it trading at historically cheap levels?

A: The Malaysian market is trading at attractive valuations against its historical average. The KLCI's Price Earnings-Ratio (PER) 3-year moving average is currently at 14.6 times FY 2004 and has in fact been declining over the past decade (i.e. the 3 year average). At current index level, the KLCI is trading at 13 times forward PER. In terms of regional comparisons, Malaysia's ratings is comparable with Hong Kong and Singapore (in fact the KLCI is trading at a slight PER discount to these 2 markets), and are generally less attractive than other markets such as Thailand, Korea and Indonesia.

Q: What are the current growth drivers for the Malaysian equity market?

A: The growth drivers for the Malaysian equity market are as follows:

1. Earnings growth - Earnings are likely to remain strong barring a sharp slowdown in the world economy. Malaysia is highly leveraged to the world economy and a continued robust global economy augurs well for the domestic economy as well. Private consumption will also lend support to the economy as demographics, high savings rates and a structural shift in spending behaviour all point to increased domestic consumption activities. The above two factors plus low interest rates should contribute to a positive stock market. Note that Malaysia's overnight policy rate is a full 170 basis points higher than the US Fed Fund rate. Also, the Central Bank has mopped up plenty of liquidity which gives it ample buffer to manoeuvre monetary policy and allow it to decouple from US interest rates.
2. Restructuring at Government-linked companies (GLCs) should provide a boost to the equity market. Recent announcements of changes to the helm of Khazanah (Malaysia's equivalent of Temasek) and at several GLCs such as Telekom and Tenaga,( plus implementation of Key Performance Indicators and Performance-Linked Compensation) have been well-received as it affirms the new administration's stance to enhance the management of such companies. While it will take time to see the results, it represents a change in mindset to improve the efficiencies and returns at these entities. Given the large weightings of these entities on the KLCI, visible improvements could have a significant impact on the market. Further, focus is also placed on improving public sector efficiency and reducing corruption. These measures combined should help reshape foreign investors' perception of Malaysia and may encourage, not just portfolio inflows, but FDIs as well.
3. M&A activities and further liberalization of the Malaysian economy is another potential driver for the equity market. We do not rule out consolidation within certain industries plus cross-border alliances or M&A activities.

Q: Have the ramifications of Barisan National's overwhelming win filtered down completely to the stock market level? Is the new administration likely to pursue reforms, and what effect will that have on the stock market?

A: Yes it has, but we think that the upcoming UMNO General Assembly in September will also have a significant bearing on the market. The results there would determine the strength of the Prime Minister's position, as well as the unity of the party. A positive outcome would be good for investor and consumer sentiment, as it will not only mean political stability but more importantly, it also consolidates the Prime Minister's position and enables him to pursue further reforms.

Q: To what extent is domestic consumption critical for economic growth?

A: We foresee that in Malaysia (in line with most Asian economies), domestic consumption will increasingly play a bigger role in driving economic growth. In this respect, Malaysia has the necessary "ingredients" given its high savings rate, low interest rates, strong employment data, and low consumption to GDP ratio. Crucially, it is private domestic consumption that has to carry the baton as government spending is likely to be constrained in line with attempts to reduce the fiscal deficit.

Q: Will competition from China affect growth in Malaysia's manufacturing sector?

A: Many of the old Asian tigers have had to contend with China attracting increasing FDIs over the past decade given its lower cost base. Like these other countries, Malaysia will have to move up the value chain and develop other sources of growth to boost its economy. Nonetheless, it is heartening to note that several MNCs are transferring back some production of higher-end products to Malaysia from China as production quality is better there. Malaysia will have to be more efficient and productive in its manufacturing sector and to this end, efforts by the new administration to improve efficiency in public agencies will help. There are also ample opportunities to develop further downstream activities to capitalize on our abundant natural resources. As such, while FDIs has slowed, there are still niche industries where Malaysia has an advantage.

Q: Financials and manufacturing account for 14% and 13% of the fund respectively. Why? Is this a significant overweight?

A: The Fund is managed on an absolute return basis and as such, we are not benchmark huggers. Nonetheless, as comparisons with the benchmark are concerned , we are underweight financials. This was a recent move as we had seen banking stocks perform very strongly over the 1st quarter, and there were also uncertainties in April regarding the introduction of a new policy rate by Bank Negara and its implications on banks' margins. At present, we may look to top up our exposure to the banking sector as it is best leveraged to consumption and economic growth. As for the manufacturing sector, there is no manufacturing sector classification in the Malaysian bourse. It goes without saying that we are positive on the selected manufacturing companies in our portfolio as we believe these companies have the potential to grow and expand their markets. While these companies may be Malaysian-owned, they are likely to have facilities overseas or are able to penetrate overseas markets with their products.

Q: In which sectors are you finding the most value at the moment? Why?

A: We think the banks are looking interesting at these levels after the recent correction. Provided the economy remains robust, banks would perform well. An added catalyst is potential consolidation within the sector. Aside from banks, we think the oil and gas sector provides very good growth potential as the structural outlook for oil remains bright. For Malaysia particularly, there is plenty of activities in this sector plus the added catalyst of Petronas encouraging local companies to improve their skill set and participate more actively in the supporting industries.

Q: To what extent is poor corporate governance still an issue in Malaysia?

A: Moving forward, if the new Prime Minister and the new chiefs at the Securities Commission and Bursa Malaysia holds true to their pledges, we think that "incidences" of poor corporate governance would decline. In a step to limit the occurrences of poor corporate governance cases, the administration is setting up a high-level corporate governance committee that will directly report to the Prime Minister on the progress of corporate investigations. We believe that these moves by the government represent a firm commitment to improve the image of Malaysia Inc.

Q: According to the investment philosophy of the fund, stock selection is based on management credibility, valuation and catalyst for price performance. Does that mean if the stock has price appreciation potential but poor management, the fund won't invest in it?

A: The three criterion is applicable for our core holdings. Our core holdings would be longer-term in nature and for which we are prepared to be patient to see the company execute its plans over time. This does not preclude us from investing in stock that does not fulfill all the three criteria. Obviously, we will be less patient with such investments and the potential returns will have to compensate for the added risks. Nonetheless, we are always clear on the reasons for investing in a stock and if those reasons are no longer valid, we are prepared to cut our position.

Q: To what extent will this fund adopt a value/growth approach? (If the investment style is a blend, then could you please give an example of when you would use both approaches.)

A: The main prerogative for the Fund will be to invest in companies that have a good business model, competent management and, excellent earnings coupled with bright growth prospects. We generally adopt an investment approach that is a mix of the two. Our approach will be largely guided by our meetings with management and our interpretation of their earnings potential. Our investment horizon can vary between short term (3-6 months) to medium to long term (6months and beyond) and through regular meetings with management and quarterly earnings updates, we will then be able to base our investment time line.