Good day from a hot and humid Kuala Lumpur. Friends tell me the weather here is mild by local standards, but I can’t say I’ve noticed. As usual, I feel I’ve stepped straight from the plane into a sauna.
Today, I want to take a look at Malaysia, and the potential it holds for investors. As we’ll see, the country faces a number of problems – but there are also some trends that make it an interesting turnaround prospect.
By the way, my apologies in advance for the lack of charts this week; I’m working over a rather slow hotel connection. Hopefully the picture will be clear enough without them…
Malaysia faces some tough challenges
Malaysia is unusual in Asia in that it’s an upper middle-income country. With a GDP per head of $14,000 in purchasing power parity terms (which adjusts for the different costs of goods and services between countries), it stands ahead of most of its neighbours, but well behind wealthier states such as Taiwan and Korea.
From here, it faces some tricky challenges as it tries to become a fully-developed country over the next decade or so. In many manufacturing sectors, local wages can no longer compete with China. So to move further up the value chain or expand its service sector, Malaysia must try to compete with nearby Singapore and other more advanced economies.
On top of this are the country’s peculiar politics. Under a system called the New Economic Policy (NEP, more recently known as the National Development Policy), ethnic Malays are favoured over other groups such as ethnic Chinese or Indians; Bumiputra (‘sons of the soil’) must hold a certain minimum stake in most businesses and are helped by recruitment and education quotas.
This came about in 1969 due to tension between the poorer Malay majority and other groups, which culminated in severe race riots. While the success of the NEP in making the country more equal is debatable, the policy has probably helped reduce social tensions. But today, it looks increasingly clumsy and unfair and more of a hindrance than a help to development.
The same government has been in power since independence, relying on policies such as the NEP to appear as a defender of Malay rights. It also portrays itself as a supporter of Islamic principles. The national religion is moderate Islam and all Malays are deemed to be Muslim, although the resulting religious restrictions don’t apply to non-Malay groups.
All of this is pretty hypocritical. There’s little overlap between the wealthy Malay elite and the poorer members of the same group elsewhere in the country; and many of their supporters seem to be recognising this and turning against them.
In general elections last year, the government’s majority dropped below two thirds for the first time. The well-meaning but ineffectual Abdullah Badawi was pushed out as prime minister ahead of schedule and replaced by his deputy Najib Razak. Infighting within the governing party has increased as different factions argue about how to see off the threat of the opposition.
What could turn Malaysia around?
These problems have soured sentiment on Malaysia for the past few years. The stock market has been one of the region’s weaker performers and new listings have dropped off, with many firms choosing to float in markets such as Singapore instead. A lack of enthusiasm for the country’s prospects has also meant weaker foreign and domestic direct investment. But several potential catalysts could turn things around:
1. The government does recognise the need to shake up the economy and increase the role of services to make up for the loss of manufacturing jobs to cheaper countries. There’s a particular focus on finance and Islamic finance; Malaysia’s Muslim heritage means it’s already a leading centre in this fast-growing industry.
To encourage foreign and domestic investment in this area, the government is now dismantling some of the NEP restrictions. It’s a step in the right direction, but we need to see more liberalisation measures follow.
2. China’s growth is an opportunity as well as a threat. It’s a key customer for many of Malaysia’s natural resources such as palm oil and rubber. It also provides investment opportunities for Malaysian firms. For example, reports that sovereign wealth fund China Investment Corporation will take a stake in Malaysian government-controlled conglomerate Sime Darby may well be the first sign of efforts to encourage closer business ties between the two countries.
3. Better relations with neighbouring Singapore could also deliver benefits for both Malaysia and the city-state. The two have a complicated history: Singapore was briefly part of newly independent Malaysia before being evicted from the union in 1965. Relations have been up and down since then, but seem to have been improving in the last few years.
With GDP per head of around $38,000, Singapore is becoming too high-cost for many of the manufacturers that still make up a large proportion of its economy. Factory wages in Malaysia are a fifth of those in Singapore, so it would make sense for Singaporean firms to begin shifting some of their operations into Malaysia. This would be good for both economies, just as both Hong Kong and Guangdong in China benefited when Hong Kong firms began shifting factories into the Shenzhen special economic zone, just across the border with the mainland.
4. Lastly, there’s the prospect of closer economic integration between the Association of South East Asian Nations (ASEAN). So far, ASEAN has been something of a disappointment. Progress has been sluggish and the hopes of a low-barriers regional trading bloc like the European Union have not been realised. However, recent free trade deals between ASEAN and several major economies have raised hopes that momentum is finally picking up. Stronger regional trade and investment links should benefit Malaysia, where local firms such as banks are already investing in less developed neighbours.
Malaysia is worth investing in – but start small
Factors like this make Malaysia an interesting turnaround prospect. Major progress on these issues would both improve the economic outlook, and cause investors to turn far more positive on the local market.
Of course, any progress is likely to be gradual. In cheap-but-troubled countries such as Thailand or South Korea, the world is in each case, awaiting a major event that will change the outlook (domestic politics and North Korea respectively) very quickly – for better or for worse. But we can’t expect that in Malaysia.
As a result, while Thailand and Korea are generally best avoided until we have a resolution, investment in Malaysia looks worthwhile. But because there’s no certainty that things will improve any time soon, I’d be inclined to start with a relatively small weighting which can be steadily increased if the long-term trend in news seems to be going in the right direction.
There are only a couple of options if you’re looking for a fund dedicated to the Malaysian market. Lyxor offers an MSCI Malaysia exchange-traded fund, listed in France, Germany and Singapore (FP:MAL), while iShares has one listed in New York (US:EWM). Total expense ratios are 0.65% and 0.52% respectively.
Alternatively, there is one small US-listed closed-ended fund, the Malaysia Fund (US:MAY), managed by Morgan Stanley, which currently trades at a discount of around 14% to net asset value. Fees are around 0.8% of assets under management.
• This article is from MoneyWeek Asia, a FREE weekly email of investment ideas and news every Monday from MoneyWeek magazine, covering the world’s fastest-developing and most exciting region. Sign up to MoneyWeek Asia here