China has not been the easiest place in which to invest over the past five years, as concerns on the long-term sustainability of its economic growth have mounted. The Invesco Perpetual Hong Kong & China fund has been one of the notable success stories in a sector that has been otherwise disappointing. The fund, run by Lorraine Kuo and Mike Shiao in Hong Kong, is bottom-up in approach, using a style it characterises as ‘sustainable value’.
The managers focus on companies with sustainable leadership of their individual market and competitive advantages, that are trading at a discount to fair value.
Mr Shiao believes that Chinese markets have pockets of inefficiency due to under and overreaction to new information, and it is these inefficiencies that he seeks to exploit. The manager outlines the four beliefs that underscore the process on the fund: “We focus only on companies where we see sustainable industry leadership, superior management and competitive advantages. We also aim to act early before a consensus is formed, by researching companies not well-covered by sell-side analysts. We have a strong valuation discipline to implement a contrarian approach and we believe in being patient.”
It is top quartile over one, three and five years and is one of only five funds in a 40-strong sector to have delivered positive returns over all those periods. It is up 89.7 per cent over five years, against an IMA China/Greater China sector average of 60.2 per cent. It is up 3.9 per cent over one year, compared to an average fall of 6.2 per cent for the wider sector.
Most recently, consumer discretionary companies have been a significant contributor to performance. However, over the longer-term, the contributors have been more diverse.
Mr Shiao says: “A number of holdings in diverse industries contributed to the aggregate outperformance. Examples would include an auto component maker, an online travel booking platform, a garment producer for Japan’s leading casual brand and a cosmetic retailer benefiting from Chinese tourism.”
On the other side, relative performance has been hurt by the lack of exposure to Macau gaming stocks. Mr Shiao says that the group’s process naturally leads it away from companies that may have good momentum, but where valuations look stretched.
He still believes these companies are vulnerable to tourism policies and are trading ahead of value. This has been mitigated to some extent by strength in tech stocks.
More recently the fund has increased exposure to healthcare-related companies. Mr Shiao says: “We have found quality within healthcare that engages in pharmaceutical outsourcing research, and healthcare services providers such as private hospitals.” The managers have been reducing the fund’s underweight position, adding to its banking exposure. It retains an underweight position in insurance and has no exposure to property.
Mr Shiao adds: “Our view is banks’ underperformance has been factored into prices after a series of negative headlines. In spite of relatively sound earnings visibility, banks are trading at depressed valuations with very decent dividend yields, and a significant underweight position is no longer warranted.”
The manager is still optimistic on the nation’s long-term potential, in spite of problems such as tightening liquidity, shadow banking issues and the possible default of trust products. He says macroeconomic reforms are proving effective and are likely to be a cornerstone of China’s long-term prosperity. However, they will take time to materialise.
