It’s striking how different perspectives can be depending on where you live and the culture you hail from. Take the dragon, for a topical example. In European folklore it’s a fire-breathing scaly beast, feared by the people for its unpredictable destructive power. Conversely in Asian traditions it is associated with wisdom, bravery and longevity; revered as a guardian and a source of good fortune.

As we enter the Lunar New Year, investors would be forgiven for steeling themselves against the threats a European-style dragon represents. Confidence, which plunged in 2011 as Europe’s debt crisis escalated and US politicians squabbled over deficit proposals, isn’t likely to recover any time soon. That said, we believe investors in Asia should welcome the Year of the Dragon with a sense of optimism. While we can’t promise that volatility is going to vanish, we see opportunities ahead for those with the courage to diversify their portfolios and to take some risks within a medium- or long-term strategy.

Busting the myths

The first step is to face the realities of 2012. The eurozone is already in recession and may take several years to fix its problems. The US is looking in better shape, but gross government debt is still rising and tensions will remain high on Capitol Hill in the run-up to the presidential and congressional elections. Growth in Asia is likely to slow too, primarily because this region cannot entirely decouple itself from the rest of the world.

What some people seem to be forgetting though is that slower growth doesn’t mean no growth. They may not break records, but the 8.6 per cent GDP expansion we forecast for China this year, and the 7.5 per cent for India, are still well into positive territory. Most Western economies would be delighted to come close.

As they struggle to decipher the political and economic headlines, we believe many equity investors are overlooking the tried-and-tested benefits of valuation analysis. A glance at the MSCI Asia ex-Japan Index’s 15-year average shows it’s now cheap by historical standards, even though we’re not living a re-run of the 2008 financial crisis, the SARS epidemic or the dot.com bubble. Europe is probably the main source of systemic risk today. Asian corporate profitability hasn’t collapsed, and we don’t expect it to.

There’s a case to be made that investors have become excessively pessimistic about the prospects for some of Asia’s leading economies. Given that China’s CSI benchmark and India’s BSE fell by 23.7 per cent and 18.9 per cent respectively last year, does it seem logical that the Eurostoxx should have dropped less or that the S&P500 should have risen? We would argue that some profitable Asian companies are now undervalued, and so their shares have potential to rise over the medium to long term.

Eyes on emerging markets

The reason we said earlier that investors should be courageous is because stocks perceived to be defensive have in many cases now lost their allure. It stands to reason that if everyone buys into companies making tinned soup then at some point those companies become overvalued. To strike the right balance, therefore, we recommend investors take informed risks after studying price-to-book and forward price-to-earnings data. Indeed, our analysis shows that investors buying at a price-to-book of about 1.5 times – the current average of the MSCI Asia ex-Japan – would have an 85 per cent probability of gains if they hold qualifying stocks for a year.

With about $120 billion of emerging market assets under management, we’re constantly seeking and testing new investment themes. At the moment, we’re attracted to emerging market industrials, materials, financials and energy; so-called cyclical sectors. Among the reasons we believe in these sectors is that we’ve seen central banks in countries including China, Brazil, Indonesia and Thailand cut interest rates (or reserve ratios) to stimulate growth as concern about inflation recedes. Many such countries still have scope to ease further and to fund development projects with bond sales, while in many Western countries rates are already near zero and public debt is significant.

We expect growth in emerging markets will increasingly be driven by domestic consumption and by urbanisation, meaning companies providing goods and services aligned to these trends are likely to benefit. Not only will these be companies selling directly to the end consumer or government, but those further back in the supply chain, such as raw commodities producers.

In defence of bonds

Many of our arguments about attractive equity valuations equally apply to corporate debt – both investment grade and high yield. Again, the flight to safety last year that saw investors dump corporate credit in favour of government risk has left the bonds of some profitable companies undervalued. Learning from the recent credit crunch, many companies in Asia and beyond have stockpiled cash, building their balance sheets as a preemptive defensive measure. Should the eurozone crisis escalate and continental European banks curb lending again, these companies will be far better equipped to fund themselves from internal resources than they were in the dark days after Lehman Brothers collapsed.

As Asia’s debt markets mature, new opportunities such as Dim Sum bonds are emerging. Chinese companies will come to this market to tap international investors, and companies from Europe and the US will come to build their credentials with Asia’s investment community. Already we see credit quality rising as greater choice enables investors to be more selective about the bonds they buy.

In summary, recognition of the challenges ahead doesn’t mean we should cower like mediaeval villagers faced with a European-style dragon. Instead, we should take our inspiration from the auspicious dragon of Asian mythology, selecting our investments carefully in readiness for an eventual return to market stability.