Raw materials save day for fund managers

Edward Hocknell withstood last month's decline in equity prices because he owned Angang Steel, one of the companies that sell raw materials in China and India. He sold Infosys Technologies, which depends on the US and Europe.

Hocknell and 99 other emerging market fund managers have raised their combined holdings in raw materials stocks to the highest percentage of assets in almost three years.

They've cut information technology to the smallest percentage in five years as on August 31, according to Emerging Portfolio Fund Research. Investors are seeking to take advantage of what Morgan Stanley calls an "emerging market-led'' global economy.

"Why would you want a company that's servicing the Western consumer?'' remarked Hocknell, whose $316 million Emerging Markets Fund has outperformed 85 per cent of its peers this year. "In the new world that we seem to be entering, what's really defensive? Probably what we like to call the 'dirty and smellys', the mining and industrial stocks.''

China's Angang Steel, which does 75 per cent of its sales at home, has gained 164 per cent this year. Infosys Technologies, India's No 2 computer-services provider, generates 90 per cent of its sales in the US and Europe. Its shares have erased almost one-sixth of their value in September.

Hocknell, 46, who manages the equivalent of $9 billion in emerging market stocks at Baillie Gifford Overseas in Edinburgh, also sold Taiwan's High Tech Computer Corporation in the second quarter.

The company, which gets more than 83 per cent of its revenues from the developed world, was unchanged this year after falling by 18 per cent from July 25 to August 16.

Portfolio makeup
After the transactions, 12 per cent of Hocknell's funds were invested in raw material producers and 5.7 per cent in technology stocks. Hocknell declined to specify his investments since June 30, the most recent quarterly disclosure.

The fund has given returns of 9.7 per cent since then, beating the 8.3 per cent gains delivered by the Morgan Stanley Capital International Emerging Markets Index. The fund has gained by 184 per cent in three years, versus the MSCI index's 164 per cent.

Hocknell and fund managers at Templeton Asset Management, AIG Investments and Morley Fund Management, who together manage $63 billion in emerging market stocks, are bidding the shares of raw materials producers to new highs.

The MSCI index of raw materials producers has climbed 40 per cent since its August 16 low to a record.

The index constituents trade at an average of 13.08 times estimated earnings. This is more than a third cheaper than the price-to-earnings ratios of industries such as industrials, at 21.04; consumer staples at 21.02; and health care at 19.41.

Changing assets
A year ago, 100 emerging market funds tracked by Boston- based EPFR had 14.2 per cent of their holdings in information technology shares and 9.3 per cent in raw materials producers. By the end of August, they increased holdings of materials companies to 13.9 per cent, the most since October 2004, while reducing infotech to 10.5 per cent, the lowest since 2002.

Merrill Lynch estimates that developing countries in Asia, West Asia, eastern Europe, Latin America and Africa will spend $1.25 trillion on roads, airports and other infrastructure projects in the next three years. Governments are trying to maintain economic growth without allowing transportation and supply delays to trigger inflation.

MSCI indexes for industrial and materials stocks have registered the biggest gains among 10 groups in emerging markets this year, advancing by 68 per cent and 64 per cent respectively. The index of information technology shares rose 7.4 per cent, in the least.

Sceptic
Antoine Van Agtmael, chairman of Emerging Markets Management in Arlington, Virginia, disagrees with Hocknell's view. He prefers technology stocks such as Samsung Electronics and Taiwan Semiconductor Manufacturing because their 4 per cent decline this year makes them cheap.

The MSCI emerging-market index of information technology shares trades at 17.22 times trailing earnings compared with 22.84 on January 2.

"After a sharp drop, the semiconductor cycle is on an upswing again,'' said Van Agtmael, who manages $20 billion in emerging market stocks. He said those who buy commodity stocks may be underestimating the impact of a slowing US economy on the raw materials demand.

Jonathan Garner, emerging market strategist at Morgan Stanley in London, said software producers will be hurt the most by the contagion from defaults on subprime mortgages, as global financial companies spend less on outsourcing.

Permanent shift
Emerging markets will add about half of the world's $3.4 trillion gross domestic product growth this year, which is triple that of the US, according to April projections by the International Monetary Fund.

"This is a permanent shift in global economic leadership,'' Garner said. Brazil's state-controlled oil company, Petroleo Brasileiro, with the largest holding in Hocknell's fund, gained by 39 per cent this year in dollars terms due to the record oil prices.

MINTING MONEY

Edward Hocknell and 99 other emerging market fund managers have raised their combined holdings in raw materials stocks to the highest percentage of assets in almost three years

He withstood last month's decline in equity prices because he owned Angang Steel, one of the companies that sell raw materials in China and India. China's Angang Steel, which does 75 per cent of its sales at home, has gained 164 per cent this year