Investors hungry for higher returns are homing in on the fast-growing economies of Southeast Asia.
In particular, they are focusing on the Philippines and Thailand, where stock-market gains have outpaced the rest of Asia this year. The Philippines' benchmark stock index is up 29.8%, and Thailand's is up 30%, compared with a 13.1% increase through Friday in the MSCI Asia ex-Japan index, an Asia-wide benchmark.
The attraction is Southeast Asia's expanding economy and rising middle class. That is likely to continue to propel stocks in the region higher next year, said David Gaud, senior portfolio manager at Edmond de Rothschild Asset Management in Hong Kong, which manages $1.5 billion in Asia and has most of its Southeast Asian investments in Indonesia, the Philippines and Thailand.
"The story is still continuing," Mr. Gaud said, adding that the Philippines and Thailand in particular are likely to benefit from improving economies. Going into 2013, "there is no reason for these markets to perform [any] less than they did this year," he says.
Morgan Stanley forecasts the four biggest economies of the region—Thailand, Malaysia, Indonesia and Singapore—will expand by 4.5% in 2013, outpacing the 3.1% global growth estimate for the same period.
Singapore shares have performed well, up nearly 16% this year, while Indonesian stocks, up 12.6%, are trading close to all-time highs. Even regional laggard Malaysia, which is up 5% for the year, has managed to pull off two of the world's largest initial public offerings in 2012.
Propelling the growth across Southeast Asia is the rising middle class, defined as those with disposable income above $3,000 a year. Brokerage CLSA Asia-Pacific Markets estimates that some 145 million people will be considered middle class in 2015, up from 95 million in 2010. That is likely to fuel increased spending on everything from food and clothing to travel and gambling. The region also is profiting from high demand for its commodities, especially from China.
As well, the Philippines and Thailand are showing signs of political stability, something that hasn't always been the case.
In the Philippines, investors say they remain confident in President Benigno Aquino III. Under his rule, the country has this year won credit-rating upgrades from Standard & Poor's and Moody's Investors Service to just one notch below investment grade.
The economy also is strong, expanding at a 7.1% pace in the third quarter, up from 6% in the previous three months.
In Bangkok, the survival of Prime Minister Yingluck Shinawatra's government has helped put a halt to years of political disruption in Thailand.
Still, a reminder of potential problems flared up last month as thousands of demonstrators rallied in the capital against Ms. Yingluck because of what they say is the continuing influence of her older brother Thaksin Shinawatra, ousted as prime minister in a 2006 coup.
"We have seen the government last more than a year and that has certainly been good for stability and business confidence," said Adithep Vanabriksha, chief investment officer for Aberdeen Asset Management in Bangkok, which has assets under management in Thailand worth around $933 million.
The strong gains in regional shares, however, have left some markets starting to look expensive, say some investors. Thailand is trading at 12.6 times earnings for the next 12 months and Indonesia is at 13.8 times, compared with 10.9 times for the MSCI Asia ex Japan.
"Valuations compared to the rest of the region are relatively high, but looking at the visibility that these countries offer over the next three to five years, they still have a case," Mr. Gaud said.
Recently, foreign investors have cooled on Thailand, selling a net 10.19 billion baht ($332 million) worth of stocks in the first three weeks of November, although they remain net buyers of 36.93 billion baht of stock for this year through Nov. 21.
"There is a decent possibility that if we look at how these markets play out, you are likely to see an exodus of people" who will take profits and exit, said Tahnoon Pasha, chief executive for equities and fixed income for Aviva Investors in Singapore, which manages assets worth $6 billion in the Asian-Pacific region.
Mr. Pasha says while the solid growth in the economies of Southeast Asia makes those markets look attractive, he is skeptical about whether foreign investors will stay.
The region's next challenge may be maintaining investor interest if sentiment toward China improves. In recent months, Mr. Pasha has been reducing exposure to the region and investing more in China as Asia's biggest economy shows signs of improvement.
Overall, though, Southeast Asia remains attractive to investors, especially as governments spend more on infrastructure in an effort to reverse years of chronic underinvestment. In Thailand, the government has implemented large-scale stimulus spending on reconstruction after last year's deadly floods, while the Philippines has been teaming up with investors to build expressways and other projects.
"Policy and politics are key across the region for the successful execution of investment-led growth," said Hozefa Topiwalla, Morgan Stanley's head of research and equity strategy for 10 countries in the Association of Southeast Asian Nations. The bank says it is "positive" on Thailand, "neutral" on Indonesia and "negative on Singapore.
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