It is no exaggeration to say that Greater China’s equity markets started 2016 on an atypical note: massive market falls in the first weeks of January set the stage for a volatile year that was compounded by a number of surprising developments on the political front. Despite these challenges, however, careful stock-picking has bolstered the performance of the Global Dragon Growth Fund, helping the team to achieve the title of ‘BENCHMARK Fund of the Year Award – Best in Class in the Hong Kong Equity category.’
Building From the Bottom Up
When asked about his investment style, fund manager Kai Kong Chay describes a philosophy of peeling back the layers to understand why an investment may or may not work. While the team does place a premium on fundamental, bottom-up research: “We are a bit different in that we always look for catalysts for the companies that we buy.” A solid record and steady sales are always good, but what is essential to Chay and his team is the why: “If we want to purchase a growth company, we look for the drivers of that growth.” Conducting this type research provides a broader picture of a company’s potential long-term success. This is where an astute manager can identify, among other things, whether the market may have mispriced a stock; “maybe where markets were too conservative regarding a stock’s growth expectations, and where there’s a high chance that the company may do better than expected,” explains Chay.
The Merits of Thorough Research
While at first glance this might seem too simple a strategy, it would be a mistake to neglect the benefits of conducting your own thorough research. When asked if he has seen any recent examples of the mispricing mentioned above, Chay offers a quick and definitive “Yes, especially in the Hong Kong-China market.” Moreover, a significant reason for this is a lack of coverage: “There are many opportunities, and many underappreciated mid-cap companies” in the region. “Because they are small (around US$1 billion in terms of market-cap), they are not very well covered by the sell-side brokers. There’s not a lot of information there.”
Therefore, it is the firms that are willing to go out and find that information that are the ones who reap the rewards (or, avoid the falls). “Manulife Asset Management has a wide network of analysts across the Greater China region that helps us to do a lot of fundamental research, talking to suppliers and their customers to understand the business model. As a result, we tend to find a lot of hidden gems.”
Never Become Too Attached
Equities make up the vast majority of assets and tend to hail from emerging, and secondarily, developed Asia. “We believe in a focused, concentrated portfolio and hold around 40 to 60 stocks,” Chay says.” When we want to add a new name, we try to do so by replacing the existing holding that has the least amount of upside. Essentially, our aim is to be disciplined and control the number of stocks to ensure that everything is meaningfully contributing.”
However, the past year presented some unusual challenges for investment managers around the world. In January, the Shanghai Composite crashed, and China’s new circuit breakers were triggered twice in the first week of trading. “2016 was a tough year,” Chay admits. “The Hang Seng Index itself was down 15% by February, then up 10% – a 25% move, then all the way back to zero again. It was very volatile.”
“As a growth manager,” he says, turning his attention to the fund, “last year was quite tough because there was some style change from growth to value. However, given the catalyst-identification process that we have, we did quite well at identifying those turnaround companies.”
This is the only real antidote to the recent uncertainty in markets; he believes: “Usually when there are bouts of volatility – such as was seen after the Brexit referendum – we stick to our fundamental research. We have a target price; we look at upside potential. I think that is the only way to find opportunity in volatility. You have to make sure that your fundamental research is strong enough to withstand it.”
Making an Active Connection
There appear to be brighter days on the horizon, particularly for investors in the Greater China region: “We are quite confident on the Stock Connect program, especially with Shenzhen added to the picture. We think there’s a lot of opportunity in the Hong Kong market, especially for the domestic Chinese insurers. There is still room to grow.” One benefit of the stock connect program, Chay notes, is greater exposure to non-renminbi equities.
Additionally, “If China’s growth is recovering, things will be better regarding tourists, and financial services. We are relatively more positive on Hong Kong banks, as well.” The Manulife MGF Dragon Growth Fund’s top exposures at the end of 2016 were to the financial and technology sectors. The Fund also invests in consumption stocks that are seeing upgrades from, as Chay puts it, ‘the new middle class.’ This includes services companies, the education sector, and tourism. Underweights are to the real estate and property sectors in both China and Hong Kong. The Fund also has an established relationship with Environmental, Social and Governance (ESG) issues. The Manulife MGF Dragon Growth Fund’s manager offers a practical reason for this: “We tend to look at it in terms of management; if a company is not ethical, it attracts more regulatory issues and could be investigated by the government.”
He leaves us with his bottom-line, somewhat contrarian wisdom, which seems to have served him well: “I think you need to have an enquiring mind: you need to look for what has not been pricing accurately. You need to think outside the box and look at non-consistent stuff. If it is consistent, everybody knows about it. When people are very bearish, you should take the other view. When people are very bullish, you should be careful. I always ask myself to think differently.” BM