17.09.2009

James Liu, Deputy CIO, APS Asset Management, Singapore

“Managers who want to do well and outperform consistently in this market have no choice but to get their hands dirty by doing their research at first hand.“

The fund was launched during November 2008 in times when the developed world was slipping into a recession but the WIOF China Performance Fund has proved itself as a good investment option achieving almost 60% in absolute terms by the end of August 2009. We can observe a considerably low correlation with developed markets during this period. What do you think has helped to boost performance and what could we expect in the 6-12 month horizon?

The manager’s good stock picking skill has enabled the portfolio to generate a return of almost 60% in absolute terms and at the same time outperform its benchmark by a big margin. We think that our proven set of investment philosophy and processes would continue to work well. As we conduct our own ground research, we should continue to generate good returns and alphas for our clients.

Your management skills have been recently acknowledged with an award for the best performing China fund. What is your experience with the Chinese market and could you reveal some of the main criteria to which you adhere to when looking for good investment opportunities in this market?

The Chinese equity market is fairly inefficient and it is also a very challenging one at the same time. Managers who want to do well and outperform consistently in this market have no choice but to get their hands dirty by doing their research at first hand. The Chinese equity market has over 1700 companies listed domestically and it is not well covered by sell side analysts. This is a challenge to many investment managers. However, it also offers some great opportunities to those who are good at stock picking and who are willing to take on the hard work of conducting all the ground research themselves. This is where and how our firm is able to identify hidden gems and generate alphas for our clients.

Some of the main criteria we look for are: 1) a strong, competent and honest management; 2) a robust and sustainable business model; 3) compelling valuations.

Chinese market and its business environment

China is one of the most influential emerging markets around the globe with the Chinese economy growing at a fast pace, the Shanghai Stock Exchange is ranked as the 2nd largest world stock market, the biggest population as well as the world’s second largest oil consumer. What are the main particularities of the “Red Dragon” as opposed to developed markets?

Though the Chinese economy has been growing at a fast pace and the Shanghai Stock Exchange has managed to reach 2nd place in the world, the Chinese equity market is still very much inefficient. Investors with strong stock picking skill should be able to locate plenty of alphas there. Foreign and institutional exposure is fairly small relative to the more developed markets, which is probably one of the reasons why the volatility of the Chinese stock market is high. In the meantime, there is a lot of liquidity in the market given its size and the limited investment alternatives that Chinese investors have. In addition, we have seen great improvements in the regulatory field. Information disclosure standard has been raised substantially especially after the QFII Scheme was introduced into China in late 2002.

According to an IMF report China’s exports are moving from textiles and apparel to electronics and machinery. What do you think of the importance of these sectors?

The labor-intensive sectors like textiles and apparel used to be a major driving force in China’s earlier economic development. Taking advantage of the abundant low-cost labor, these sectors had helped bring in the once much needed foreign reserves and increase household income by providing employment opportunities to a large number of the population.

However, with the economy moving into the next development stage, there is the inevitable need to shift from the labor intensive, low value-add industries to tech intensive, high value-add sectors in the export structure. While making textiles in China is losing competitiveness due to rising labor costs and more stringent environmental regulations, electronics and machinery exporters have access to a vast supply of qualified engineers and skilled workers, as well as complete supply chains. These higher value-add industries are not only coming up as key export sectors, but also providing a more sustainable driver for the overall economic development.

We can agree that China is a communist country yet with many capitalistic features. Do you think that the business environment has improved over the last few decades? What do you think were the main benefits for foreign companies entering China from the government side?

Definitely we agree that the business environment in China has improved significantly over the last few decades and many foreign investors or businessmen hold the same view.

From the government’s point of view, foreign companies entering China will bring in new capital, thus helping generate employment, introduce new technology and products to the country and enhance the managerial and technical skills of the people. However, things have changed quite a bit over the last few years as China is becoming more affluent and now what China needs more out of these foreign ventures are technology and management expertise.

Boost to the economy and economic recovery

The government is currently running a stimulus package worth USD586 bn. Which sectors profit the most and what do you think could come after the package effect vanishes?

The infrastructure related and capital goods manufacturers are those that benefit the most out of this stimulus package. We think the Chinese government will make sure that the economic recovery can be sustained after the first package’s effect vanishes. We have actually noticed that the government has been introducing various measures to boost domestic consumption since early this year. At the same time, they are supporting the export sector by increasing VAT rebates to exporters and offering other incentives for them to stay viable under these challenging times. Should it be necessary and if there be no clear signs of recovery, there is a good chance that the Chinese government will go ahead with a second package to stimulate the economy.

Analysts have supposed that the Asian region will not recover until after the US and Europe had revived. However Asia’s presumably export driven economies have recovered before the rest of the world. What do you think was behind this impressive development?

We think that the main reasons behind are: 1) continued growth in China and India, though at a slower pace; 2) businesses and households in Asia were hurt less than in western economies as they are not much leveraged; 3) as in other economies, the governments here are able to come up with a loose monetary and an expansionary fiscal policies. At the same time, they have introduced a slew of measures to stimulate domestic demand.

China’s economy seems to be prospering well despite the global downturn. There are some concerns of its rising influence as many companies and countries around the world found themselves unable to fund their businesses and activities. Do you think that the crisis has been and is a unique opportunity for China?

We think that this time around, the crisis offers some really good opportunities to Chinese corporates, especially those with deep pockets. Many of them have taken the opportunity to go overseas by acquiring or taking strategic stakes in foreign firms with natural resources, technology, comprehensive distribution networks, etc. However, their approach to some of these M&A cases may need to be refined, as it is typical for a Chinese company to want to take a majority stake. This really scares some of public shareholders or even sometimes the government of the country where these firms are located.

The main markets for China’s products are US and Europe. Do you think that the recovery which seems to be round the corner will help enhance China’s growth?

There is no doubt about it. While we acknowledge that the government has done a good job in stimulating domestic demand, export still accounts for around 30% of China’s GDP. The slowdown in exports due to the recent economic crisis had shaved 2.9% off GDP growth in the first half of 2009, according to some economists.

However, the good news is that China’s share in the global export market has been stable. So, a recovery in the developed markets will lend momentum to China’s growth.

Chinese market particularities and actual issues

One of China’s weaknesses is its constantly rising oil demand. The price of gasoline is currently one of the lowest in the world though has recently climbed by 4-5% and a further rise is expected. Do you think that it could have a notable impact on consumer spending and production?

Oil prices have become a more important part of people’s lives with growing car ownership in China. It’s fair to say that a series of increases in gasoline prices within a short span of time would probably have a notable effect. But in the longer term, as long as average household income continues to increase at a faster rate, consumer spending will remain strong.

As a result of international trading, the impact of increasing energy prices on industrial production is probably a global issue, and not just restricted to China. Higher energy costs will inevitably lead to more expensive products, which will dampen demand and cause inflation. Global recovery, including China’s exports, risks being slowed if oil prices surge too rapidly.

World Oil Demand Ranking 2007

Country

%

United States

30%

China

11%

Japan

7%

Russia

4%

India

4%

Germany

4%

Mexico

3%

Canada

3%

Saudi Arabia

3%

Korea, South

3%

Other

27%

 

 

Source: www.nationmaster.com

The Middle East is its main oil importer supplying it with 58% of China’s oil imports. Undoubtedly access to Middle East oil will become a key issue in relations with the US. Therefore China is focusing on oil development projects outside the Middle East, in regions such as Africa. How do you perceive this implication?

It is strategically important that China maintain a sustainable energy supply from Africa, and this aim can probably be achieved in mutually beneficial ways. Africa can satisfy China’s need for oil, and China can lend a hand in tackling the obstacles to Africa’s sustainable development. For instance, China can bring in the much needed foreign investments, and help rebuild dilapidated infrastructure. Thus, going forward it’s reasonable to expect closer economic relationships between China and African countries. However, implementing such a strategy is not without risks. Besides inherent business and political risks in Africa, such a move may subject China to criticism and pressure from the western world.

China has recently cut commodity imports to reduce overcapacity in industries such as steel and cement. What do you think would be the impact as some analysts have put on record that it may undermine growth and destabilize the political establishment?

Overcapacity is indeed a problem that exists in a few industries in China, for example, steel, cement, glass, coal chemical, poly silicon, wind power equipment, etc. This is a result of lack of planning and disorderly competition. The Chinese government is well aware of this issue and wants to make sure its USD 586 billion stimulus package will not make the problem worse.

The State Council has recently issued directives to regulate the capacity growth in these industries, for a healthier development in the long term and the stability of the overall economy. This has been well understood and received by the public. Analysts have probably gone too far in suggesting that the stability of the political establishment is at jeopardy due to some of these directives.

China’s Sovereign Wealth Funds (CSWF) emerged as a result of China’s growing foreign exchange reserves. Some call it cross-border investment but others cross-border nationalization. Though the assets of CSWF have recently experienced a serious decline its importance is still held in high regard by many critics. Hence what are the implications that should be taken into consideration for China’s and global markets especially for US economy?

In general, sovereign wealth funds, including CSWF, have great potential to grow, as a result of rising national wealth created, especially in emerging countries and energy exporting countries.

To be a responsible manager for the public wealth, CSWF will likely seek international diversification in the asset classes it invests into, with a bias towards industries that are strategic to the country’s growth, for instance, natural resources. CSWF will also join other SWFs in creating more demand in equities, bonds, commodities, and real estates, etc.Generally people welcome stable, long-term, and sizable funds, as their capital can help economic development. In principal, the same should be true for CSWF investment in the US, barring political blockades. On the other hand, CSWF may provide alternative investment opportunities for China’s foreign reserves. Should China meaningfully diversify its reserves away from US treasuries, there will be palpable impact on yields.

China’s cost of reducing greenhouse gas emission is likely to reach USD438bn within 20 years. This is apparently related to rising oil demand driven by increasing production and the increase in the usage of automobiles on a large scale. Do you think that the cost would contribute to an improvement in production efficiency or could it harm production?

In the long run, industrial production and the usage of automobiles will not decline; instead they can only increase, as a result of rising living standards. Environment protection measures and the costs incurred will not change the trend.

Against this backdrop, those that can mitigate the impact of rising environmental protection costs will win the game and stay competitive. In order to do this, there are great incentives for them to innovate and upgrade production processes, which will lead to better production efficiency.

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