Investors Flirt With Malaysia Again -- at Their Own Risk

Reinstatement to Morgan Stanley indices lures traders, but professionals remain wary.
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Malaysia is an unlikely place for sudden investor interest.

It is, after all, the country that prevented investors from taking their money out of the country by imposing capital controls during the financial crisis of 1998. It is the country whose leader, Prime Minister

Mahatir Mohammed

, blamed Malaysia's economic woes on Jewish foreign investors conspiring to bankrupt and destroy the nation -- and who tossed Anwar Ibrahim, his talented finance minister, into prison for having the temerity to suggest his boss' approach was mistaken.

Not surprisingly, that experience soured most investors on Malaysia.

Nevertheless, Malaysian stocks are suddenly as hot as the country's tropical climate. The benchmark

KLSE Composite

stock index is up 15% since the beginning of the year, second in Asia only to China's

Shanghai Composite

, which is up 28% over the same period.

The benchmark Malaysian index is outperforming the


(up 1% since Jan. 1) and the


(up 9%). More than $2 billion in net foreign portfolio investment has flowed into the country since the beginning of the year, a relatively insignificant amount by U.S. standards, but not bad for an emerging market. More important, if the trend continues, this year will be the first since the crisis that more foreigners put money into Malaysia than have taken it out. Despite the unpleasant recent history, investors seem to be both forgiving and forgetting.

While the short-term memory of investors may be baffling, what drives this surge in Malaysia is clear. It is the decision made last fall by

Morgan Stanley Capital International

to reinstate Malaysia in three of its indices: the

Emerging Markets Free

, the

All Country Far East Free ex-Japan

and the

All Country Free

. Malaysia had been removed following the imposition of capital controls. Its reinstatement, which occurs in May, means that many investors, particularly institutional investors who use those MSCI indices as benchmarks, will automatically invest in the country. (


explored a similar development in China on

Thursday.) Other investors are getting in now, anticipating that the new flows of capital will cause the market to rise.

Meanwhile, there has been some good economic news in Malaysia recently.

Gross domestic product grew by 5.4% last year, and the government estimates growth this year in the 6% range. Industrial production grew an impressive 20% last year. Politically, the country is stable, with Mahatir, for better or worse, firmly in command after winning re-election last fall and surviving a challenge to his leadership of the ruling party just a couple of weeks ago. And most of the restrictions on capital flow were removed.

At first glance, then, Malaysia seems a good bet for the daring investor. But despite the rush of money into the country, the recent strong returns in the market and the promise of more money, many professional investors are unenthusiastic.

Malaysia's economy is "built on eggshells," says one fund manager, who asked not to be identified because of the difficulties his firm has had with the Malaysian government. "There are other more interesting opportunities elsewhere in Asia," says Eswar Menon, portfolio manager at


Loomis Sayles International Equity fund.

Others are more bullish -- barely. "I wouldn't tell investors not to invest in Malaysia," says Steven Schoenfeld, portfolio manager at

Barclay's Global Investors

. "The economy is quite good, but I don't want to be Panglossian."

Schoenfeld thinks the MSCI boost is mostly hype. He notes that MSCI is not including Malaysia in its

Europe, Australasia and Far East

index, or EAFE, in which it had been included previously. More funds use the EAFE index as a benchmark than the ones Malaysia will be in. "The expectation of a nirvana of a flow until May is overblown," he says. "If Malaysia rallies, it is because Asia as a whole has gotten a second wind."

Investors have limited opportunities in Malaysia, although many Americans will be investing there come May if they have 401(k) funds that include investments in emerging markets. Trading of Malaysian American Depositary Receipts -- U.S. listed shares of Malaysian companies deposited and traded in this country -- was halted after the capital controls were imposed, and has not resumed. The opportunities that do exist have been lackluster, despite the strong market performance.


(EWM) - Get Report

, which tracks the MSCI Malaysian index, climbed 32% after MSCI's announcement but has been essentially flat since the beginning of the year. The


Malaysia Fund


is another option. It's down 10% since the beginning of the year.

Malaysia escaped the Asia crisis relatively unscathed, falling into recession but not to the extent of some of its Asian neighbors. However, that in turn meant Malaysia never made significant structural reforms to the economy, as did other countries in the region following the crisis -- reforms that give investors more optimism for the long-term performance of those countries. To some, Mahatir now looks like a cranky, yet bold, economic visionary instead of someone who is just very lucky. His luck may not hold forever.

David Kurapka's Global Portfolio column appears Wednesdays and Fridays on TSC. In keeping with TSC's editorial policy, he does not own shares in any companies or mutual funds mentioned in this column. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at