OCTOBER 2009 Noriyuki Oharazawa, Index Strategy Director, Japan

Asian equity markets: A closer look

Just over a year after the collapse of Lehman Brothers precipitated global economic turmoil, Asian countries have led the world in recovery. Global investors are taking note. Investors in Asian equities need to understand not only differences between Asian and Western developed markets, but also differences among Asian countries. Historical returns, growth patterns and the recovery experience differ across the region. Our research illuminates how the structure of the overall Asian equities market has changed over the past 10 years. We note the differential performanceboth recent and long-term-between Asia and Asia ex-Japan; the increasing importance of Asia in world equity markets and of China within Asia; and significant differences in style across the region.
Equity market performance: Spotlight on Asia ex-Japan
Fast recovery from the Lehman shock: Asia ex-Japan leads the region and the world

The Lehman shock of September 15, 2008, had a seismic effect on Asian economies. GDP declined not only in financial districts such as Hong Kong and Singapore, but also in other Asian countries whose economies are highly concentrated in manufacturing due to the sharp decrease in demand for goods from Western countries. The Asia ex-Japan market saw this effect at the outset; by November 2008 its (U.S. dollar denominated) returns had dropped even more precipitately than had the U.S. and European markets performances. In just a few months, however, Asian financial markets began to recover as Chinas expanding domestic demand for manufactured goods helped bolster the Asian economy. Asian markets first saw signs of recovery in second-quarter 2009, and the trend turned markedly upward in March. By the end of July 2009, price levels were back to where they had been before the Lehman shock (August 2008). At that time, U.S. and European markets had recovered only up to 80%.

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Figure 1 illustrates the Asian markets fast recovery pace compared to other regions since August 2008. While each of the broad regions experienced severe drop at the outset, the graph demonstrates the relative out-performance of the Asia ex-Japan region as markets begin to recover.

Figure 1 / Performance Recovery after the Lehman Shock

120

Growth of $100 August 2008 - September 2009

100

80

60

40
08 -08 t -08 08 09 r-09 r-09 y-09 -09 l-09 09 09 08 gv- ecgn- ebp c a o u a un e Ju Au O Ap Ma J M J A N F S D

Asia

Asia ex-Japan

USA

Developed Europe

Asia is represented by the Russell Asia Pacific Index; Asia ex-Japan is represented by the Russell Asia ex-Japan Index; USA is represented by the Russell 3000 Index; Developed Europe is represented by the Russell Developed Europe Index. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

The longer term performance perspective:.Asia ex-Japan still leads

In addition to leading the recovery, Asia ex-Japan markets had outstanding performance in the years leading up to the crisis. When viewed over longer time horizons, the Asia ex-Japan market has had very attractive performance relative to other regions. Figure 2 represents the (U.S. dollardenominated) annualized returns for the past three, five and ten years.

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Figure 2 / Longer Term Performance

20
Annualized returns (%)

15 10 5 0 -5 -10 Last 3 years Asia

As of 8/31/2009 Asia is represented by the Russell Asia Pacific Index; Asia ex-Japan is represented by the Russell Asia ex-Japan Index; USA is represented by the Russell 3000 Index; Developed Europe is represented by the Russell Developed Europe Index. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Last 5 years USA

Last 10 years Developed Europe

Asia ex-Japan

Equity market structure: The growth of Asia fueled by China

Changes in global market structure

The weight of Asia among global markets has steadily been increasing. Figure 3 represents the weights of the major regions that make up the Russell Global Index from 1997 to 2009. The U.S. and European markets have consistently represented the majority of global markets. However, the long-term trend shows a decrease in the U.S. market weight and an increase in weight represented by the Asian region.

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Figure 3 / Changes in Regional Weights

100 Others 80

% of Global

Developed Europe 60 USA 40 Asia ex-Japan 20 Japan 0

97 19 98 19 99 19 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20

As of 8/31 for each year Japan is represented by the Japan portion of the Russell Global Index; Asia ex-Japan is represented by the Russell Asia ex-Japan Index; USA is represented by the Russell 3000 Index; Developed Europe is represented by the Russell Developed Europe Index. Indexes are unmanaged and cannot be invested in directly. Data is historical, is not a guarantee of future performance, and is not indicative of any specific investment.

Figure 4 shows the change in Global market weighting for each region over one, three, five and ten year time periods ending in August 2009. Within a year after the Lehman shock, the Asia weight has increased by 2.6%, and the U.S. weight has decreased by 2.4%. When August 2009 country weights are compared with those of 10 years ago, the Asia region increased by 6.4% and the U.S. has decreased by 15.9%. This is caused by relative performance among the regions; equity markets that grow faster than average will increase their weight relative to markets that grow slower than average. If Asian equity markets continue to grow at a faster pace than the U.S. and other developed markets, their relative weight will continue to increase.

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Figure 4 / Changes in Regional Weights within the Russell Global Index

10 5

Difference (%)

0 -5 -10 -15 -20 Last 1 year Asia Last 3 years Asia ex-Japan Last 5 years USA Last 10 years

Developed Europe

As of 8/31/2009 Asia is represented by the Russell Asia ex-Japan Index plus Japan portion of the Russell Global Index; Asia ex-Japan is represented by the Russell Asia ex-Japan Index; USA is represented by the Russell 3000 Index; Developed Europe is represented by the Russell Developed Europe Index. Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Fast turnover in Asian country market value rankings: The rise of China

Within Asia, there is also a new dynamic taking place that underlies the growth of the region. Although Japan historically has been the largest market in Asia, its relative weighting has declined considerably in the past 10 years, from 77.5% to 50.3%. Even among the ex-Japan countries there has been a significant shift in relative position. Figure 5 shows that South Korea, Taiwan, and Hong Kong have traditionally shared dominance, only to be overtaken by China in recent periods.

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Figure 5 / Changes in Country Weights in Asia and Asia ex-Japan 1999-2000

Russell 1999 Asia Pacific 2004 Index 2009 Russell 1999 Asia ex2004 Japan Index 2009

Japan Japan Japan South Korea Taiwan China Hong Kong Taiwan

South Korea Hong Kong South Korea Taiwan

Japan Singapore Thailand

As of 8/31/2009

South Korea Malaysia Indonesia

Hong Kong India Others

Taiwan China

Each country is represented by the Russell Indexes for respective country Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

The prominence of China becomes especially evident when considering the historical makeup of the Greater China region (China, Taiwan, and Hong Kong). While China is recognized today to be the core country of the Greater China equity market, Figure 6 highlights that the core markets from the perspective of foreign investors were Taiwan 5 years ago and Hong Kong 10 years ago.

Figure 6 / Changes in Country Weights within the Russell Greater China Index

1999

Hong Kong

Taiwan

China

2004

Taiwan

Hong Kong

China

2009

China

Taiwan

Hong Kong

As of 8/31/2009

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Asia vs Asia ex-Japan: The element of style

Asia ex-Japan has shifted to growth

In addition to the substantial shift among countries, the Asian region is also experiencing a major shift in style characteristics. Figure 7 illustrates style mapping for Asian countries as of August 31, 2009. Major countries are plotted with the horizontal axis representing the growth ratio and the vertical axis representing the large cap ratio. Asian countries vary considerably in size and style, but the majority of countries exhibit strong growth style characteristics; Japans large weight and substantial tilt towards value make the Asia region overall appear more value oriented; however, when Japan is removed it is apparent that the Asia ex-Japan region is actually a growth-oriented region.

Figure 7 / Style Mapping for Asian Countries based upon Value and Growth, Large and Small Cap Russell Indexes for each Country

100
China

Large

Japan

South Korea Asia ex-Japan Asia India Indonesia Taiw an Malaysia Singapore

(%)
Small

Hong Kong

Thailand

50 0
Value
As of 8/31/2009

50

Growth

100

Figure 8 shows how the size and style characteristics of the Asia ex-Japan market have changed over time. Based on Russells global-relative style methodology1, Asia ex-Japan was somewhat value oriented in the early part of the decade, but since that time has shown increasing growth characteristics. Although the region has shifted towards value slightly by the end of August 2009, the market continues to be heavily weighted in growth stocks.

David Carino. 2008. Global Style Indexes: Validating the Russell Style Methodology, Russell Research http://www.russell.com/indexes/QuarterlyResearch/Articles/November2009/Global_Style_IndexesValidating_Russell_Methodology.pdf

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Figure 8 / Changes in Size and Style Exposures in the Russell Asia ex-Japan Index 2001-2009

100
Large
2009 2006

(%)

2007 2004

2008

2003 2005 2001 2002

Small
Asia ex-Japan

50 30
Value

50

Growth

70

As of 8/31 for each year Data is historical, is not a guarantee of future performance, and is not indicative of any specific investment

Conclusion
Asian equity markets have exhibited attractive performance characteristics relative to other regional stock markets for a long time. Asian stocks have led the world over the last six to nine months as markets and economies recover from the meltdown experienced in the fall of 2009, following the Lehman bankruptcy. Investors wishing to participate in Asian equity markets need to be cognizant of differences across the region: all Asian equity markets are not created equal. They are distinguished by differentials in equity market performance, differential growth in stock market valuations and by style. The positive performanceboth recent and long-termhas been greatest in Asia ex-Japan. The increased weight of Asia in the structure of global equity markets reflects the growing importance of China. Asia ex-Japan has become a growth market, while Asia as a whole, still dominated by Japan, tilts strongly toward value.

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For more information about Russell Indexes call us or visit www.russell.com/indexes. Americas: +1-877-503-6437; Asia: +81-3-5772-8385; EMEA: +44-0-20-7024-6600 Disclosures
Non-U.S. markets entail different risks than those typically associated with U.S. markets, including currency fluctuations, political and economic instability, accounting changes, and foreign taxation. Securities may be less liquid and more volatile. Russell Investments is a Washington, USA Corporation, which operates through subsidiaries worldwide and is a subsidiary of The Northwestern Mutual Life Insurance Company. Russell Investments is the owner of the trademarks, service marks and copyrights related to its respective indexes. Indexes are unmanaged and cannot be invested in directly. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an as is basis without warranty. Unless otherwise noted, source for the data in this document is Russell Investments. This is not an offer, solicitation or recommendation to purchase any security or the services of any organization. Copyright Russell Investments 2009. All rights reserved. First use: November 2009. CORP-5870

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