Investing in Indonesia is starting to look just as attractive as China and India, writes John Collett.
While everyone knows about the merits of investing in China and India, Indonesia barely rates a mention. But fund managers who specialise in Asian shares say the archipelago presents investment opportunities every bit as good as China and India over the long term.
With more than 240 million people, Indonesia is the world's fourth-most populous country. Like India and China, it has a rapidly growing middle class. Its economy may only be half the size of Australia's but it is growing at almost 7 per cent a year.
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It rivals Australia as a commodities exporter and Indonesian companies are the most profitable in Asia. It's a far cry from 1997, when the Indonesian government was forced to nationalise the banks after the country was among the most badly hit by the east Asian financial crisis.
As a developing country, Indonesia faces huge challenges but it is enjoying political stability, its sharemarket is attractive and there's a good selection of quality stocks in the resources sector, banking and consumer stocks.
Since his election as president in 2004, "SBY" (Susilo Bambang Yudhoyono) has changed the investment landscape, according to the Asia portfolio manager at fund manager Five Oceans Asset Management, Rob Nunley.
"He has done a very good job of turning things around in the economy," Nunley says. "Those positives we see in India and China - the middle-class income growth, the positive demographics and urbanisation - exist in Indonesia."
Tens of millions of low-income Indonesians are expected to join the middle class in the next 10 years, which puts Indonesia behind only India and China in terms of the size of the growing consumer market. The youthfulness of its population puts it behind only India and Vietnam in the Asian region.
"The long-term prospects for Indonesia are extremely good," says Kerry Series, the chief investment officer at Eight Investment Partners, which runs the 8IP Asia Pacific Partners Fund. "There are a number of really interesting companies in Indonesia and some of the consumer stocks, in particular, are really good-quality companies."
An example is Ace Hardware, which is listed in Indonesia and is a franchise of a US company. Ace Hardware sells everything from outdoor furniture to power tools. Series says the "return on equity" (a measure of profitability favoured by fund managers) of the companies that make up Indonesia's sharemarket index is more than 20 per cent. No other country in Asia has such high profitability, he says.
Robin Parbrook, who manages the Schroder Asia Pacific Fund from Hong Kong, prefers Indonesia to China and India. "Even though Indonesia has slower economic growth than China, it has a much better stockmarket," he says.
Many Chinese companies are majority government-owned and there is a lot of investor money chasing Chinese stocks.
Parbrook says the current worries with India include the high valuations of Indian shares, rising inflation and a "lot of hot money" that went into India last year.
There is no doubt that Indonesian shares are more expensive than their historical averages following that sharemarket's massive gains over the past two years. In 2009, the Indonesian sharemarket rose more than 85 per cent, in US dollar terms, after it fell sharply during the GFC. In 2010, it rose more than 45 per cent but it has been trading sideways since the start of this year.
Parbrook says Indonesian shares are not that expensive. The sharemarket has historically traded at big discounts to the region because of corruption and after the country experienced the problem of the east Asian financial crisis.
"Indonesia has a lot of potential and it is one of our key overweights in the fund," says Ragu Sivanesarajah, who helps run AMP Capital Investors' Asia Equity Growth Fund. The fund has about 6 per cent of its money invested in Indonesian-listed shares - large relative to the small size of its sharemarket.
Sivanesarajah, a senior portfolio manager with the Asian equities team, says there is no reason why Indonesia's good economic growth rates should not continue.
Eng-Teck Tan, the investment manager of the TAAM New Asia Fund, based in Singapore, says his fund sold all its Indonesian shares - to take profits - in October last year. "There is no doubt that it is very easy to fall in love with Indonesia," he says. "There's its huge population and it is resources rich but the market has run ahead of itself in the short term."
Consumer stocks are expensive, he says. And the stocks that are cheap are the ones that Tan would not want to own. He can find cheaper stocks in Thailand, China and India. Like most emerging economies, Indonesia has its fair share of challenges. Corruption and inefficiency remain significant problems. Many of the leading companies have families as majority owners and corporate government standards can be low.
Some fund managers prefer to hold exposure to Indonesia to companies that are listed on other stock exchanges in Asia, such as Singapore, and have significant business operations in Indonesia.
One of Indonesia's biggest challenges is putting in place the infrastructure, such as roads, ports and rail, so that its enormous commodities-producing potential can be realised.
Investing in emerging markets is always risky. For small investors, the way to gain exposure to Indonesia is through a fund that invests in Asia, says the editorial and communications manager at investment researcher Morningstar, Phillip Gray. He says choosing specialist funds such as those that invest in Asia offers many growth opportunities. However, specialist funds have their own particular risks and should be used as part of a well-diversified portfolio.
Five Oceans' Rob Nunley has holdings in Bank Mandiri, Indonesia's largest bank, which has restructured its balance sheet and is "very well run".
For exposure to Indonesia's rapidly growing coal sector, Five Oceans is invested in Banpu, which is listed in the Thai sharemarket and owns a large Indonesian coal miner. Banpu recently bought Australian miner Centennial Coal.
Five Oceans also holds shares in the Singapore-listed Jardine Matheson, a "blue chip" company that majority owns the Indonesian conglomerate Astra International, which among other things, makes and distributes motorcycles and cars. The fund manager also owns the Indonesian-listed Indocement.
Kerry Series of Eight Investment Partners holds shares in the Indonesian-listed Adaro Energy and Straits Asia Resources, which is listed in Singapore and owns mines in Indonesia. He is invested directly in Astra International rather than through the parent, Jardine Matheson.
Schroder Asia Pacific Fund is invested in Jardine Matheson, which is the fund's third-largest holding. Schroders' Robin Parbrook favours the Indonesian consumer sector. He says the banks are "good, long-term growth stories" but a "bit too expensive" at the moment. "We will look to buy Indonesian stocks on the dips [in share prices] but the long-term story is good," he says.