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Global investors are more conservative on emerging Asian stocks compared with equities elsewhere, as concerns about poor corporate governance and lack of transparency are taking some of the gloss off the region's outperforming markets.
The problems are particularly acute in China, South Korea and Taiwan, which make up more than half of the benchmark MSCI Emerging Markets index.
As a result, international investors are more selective about where they put their money and are underweight Asian equities even as economic growth and stock returns in the region continue to outpace other emerging markets such as those in Latin America.
"While there are opportunities among selected companies in Asia, we have reservations about the quality of companies that make up a significant portion of the index," said Matthew Vaight, London-based manager of M&G Global's Emerging Markets fund. "We will struggle to move to a significant overweight in Asia."
Global emerging markets funds had only 63% of their investments in Asia as of May 31, below the benchmark's weighting of 69.7%, according to a survey of 51 funds by J P Morgan last month.
Among major emerging markets, countries with the biggest gaps between investors' positions and the benchmark were Malaysia, Taiwan, Korea and China, according to the survey.
GOVERNANCE STRUGGLE
The underweight position on emerging Asia comes despite the outperformance of the broader index.
The MSCI Asia Emerging Market index has fallen only 5.3% over the past year, compared with a 32% slide in its Latin American counterpart and an 18% decline in European and Middle Eastern emerging markets.
"We struggle to find companies that satisfy our quality criteria," particularly in north Asia, said Christopher Wong, senior investment manager at Aberdeen Asset Management in Singapore, who runs its emerging markets fund. "We are uncomfortable with the opaque business structures and the generally poor corporate governance standards."
Take the case of China and South Korea, for example.
Although Beijing is undertaking reforms, the inefficiency of its state-owned enterprises, including its Big Four banks - Industrial & Commercial Bank of China, China Construction Bank, Agricultural Bank of China and Bank of China - has long been one of the country's thorniest problems.
In South Korea, Samsung Group's founding Lee family - which controls global electronics giant Samsung Electronics - last week scored a narrow win in a landmark proxy battle, led by activist US hedge fund Elliott Associates.
The rare challenge by a foreign fund has stirred public debate about the country's corporate-governance standards, especially amid growing disenchantment with family-owned businesses running rough-shod over minority interests.
Aberdeen's emerging markets fund had 55.9% of its investments in Asia as of May 31. It has been underweight Asia, particularly China, Taiwan and Korea, for 10 years.
INDIAN OPPORTUNITY
In contrast, while Latin American economies aren't exactly brimming with confidence, the fund is more exposed to the region than the benchmark.
Companies including retailer Lojas Renner
To be sure, some funds are taking the opportunistic approach in places like South Korea.
M&G Global's Vaight says concerns about corporate governance have compressed valuations to the point where they're attractive.
Korean companies are trading at 11.6 times earnings, which for instance compares with 15.8 in Indonesia and 16.7 in Thailand.
India, home to the biggest number of overweight positions among emerging market funds and favored by global equities funds, is an exception despite the Sensex's high 20.5 times earnings multiple.
"The only appealing investment right now in Asia is India," said Chris Semenuk, manager of TIAA-CREF's $4.3 billion international equities fund, which is underweight Asia.
"India, in its development, is where China was 10 years ago. The runway for future growth in Indian companies is quite long."
