Scilla Huang Sun, head of equities at Swiss&Global Asset Management and fund manager of the Julius Baer Luxury Brands Fund, explains why Asian consumers are helping to make luxury stocks a shining investment.

Rising wealth, especially in
Asia-Pacific

Wealth
creation is the main driver of luxury spending, and strong economic growth
leads to rising wealth especially in emerging markets. The number of affluent
households is expected to double from 2010 to 2020. This bodes well for the
long-term growth of the luxury industry, as there are more and more consumers
who can afford buying luxury.

2011 started off well, and the outlook for the
year remains promising. Top brands like LVMH and Burberry reported double-digit
growth rates. All major luxury product categories and regions are doing well,
except Japan.

China, the fastest growing market, shows no signs of slowdown.
The tragic events in Japan which represent around ten per cent of global sales
impacted sales but luxury demand is recovering faster than most expected. We
expect luxury sales to advance by at least seven to ten per cent this year,
driven by Asia and also by renewed strength of high-end consumption in the
West.

Crazy for Western luxury brands

Many
Asian consumers aspire to own Western luxury brands. They like status symbols
and are not shy to show their achievements by wearing aRolex watch or carrying
a Hermès bag. Consumers from emerging markets today already buy half of all
luxury goods and account for the majority of growth. The Chinese are the most
important luxury consumers. They rank fourth in number of millionaires, behind the US, Japan and Germany, buying nearly one quarter of all
luxury products. There is so much pent-up demand for luxury that growth will be
strong for several years to come.

The affection for a luxury brand can be so
strong that a Chinese will spend a full month’s salary on a Louis Vuitton
handbag! Even if there is a slowdown in the Chinese economy, the impact on
luxury demand will most likely be limited and only short-lived as the increase
in purchasing power of Chinese consumers is secular.

Prada, Ferragamo, Moncler, Jimmy Choo, Bulgari and Hermès in the M&A headlines

After their stellar performance over the last two years, luxury stocks have been
attracting corporate interest, making big headlines over the last few months.
LVMH took over Bulgari and a big stake in Hermès recently. Instead of doing an
initial public offering, Moncler and Jimmy Choo shoes were sold to private
equity firms. Samsonite, Prada and Ferragamo are all listing as publicly traded
companies in Hong Kong and Milan.

Strong
brands with great investment fundamentals at reasonable price

Luxury
stocks are not just a quirky investment. Although valuations of listed luxury
companies have rerated from their lows in 2009, they are now priced around
their historical average multiples but have better fundamentals than five years
ago.

Luxury companies have increased their exposure to high growth Asian
consumption and have better cost controls overall. The luxury industry is
growing, and strong brands are highly profitable. We expect well-managed luxury
companies to outperform the broader equity market in the coming three to five
years.

Pricing
power protects margins

Many
industries are suffering from rising cost inflation, leading to margin pressure
and less profit, but luxury is affected to a lesser extent. Raw materials on
average account for only ten to fifteen per cent of sales. Also, most luxury
products are made in Europe and not in Asia, where wages are increasing at a
double-digit pace. Thanks to luxury producers’ pricing power, cost increases
can be passed on to consumers without much impact on demand. Many luxury
companies have increased prices by five per cent to ten per cent already this
year.

Winners and Losers

Brands
that I like are Louis Vuitton, Hermès, Cartier, Omega, Tod's, Burberry, Tiffany
and Estee Lauder. They are all very global and well managed. We still like watches as they also
look attractively valued. We continue to like shoes of top brands as these
companies have high pricing power and are less affected by global inflation and
cost increases.

We have cut high-end beverages due to their greater exposure to
southern Europe where consumers are suffering and also we perceive their
ability to pass on higher raw-material prices to consumers, are more limited
than watches and accessories brands.