The Hong Kong market experienced a bumper year in 2017, and so did Manulife Asset Management. The investment powerhouse successfully captured the year-long winning streak of Hong Kong stocks and created tremendous value for investors. We seized the chance to talk to Kai Kong Chay, Managing Director, Senior Portfolio Manager of Greater China Equities, about his allocation strategy in the city’s elusive investment landscape.
BENCHMARK (BM): Your flagship Manulife Dragon Growth Fund delivered stellar performance last year. After the significant rally, do you think the high valuations of your key holdings are still reasonable?
Kai Kong Chay (KK): Indeed, we’re well aware of the elevated valuations of our major holdings, especially the two Chinese Internet stocks in our top-10 list. However, let’s not forget that the expanding earnings multiples are, in fact, built on strong business fundamentals. For example, the leading Chinese Internet companies are employing AI to improve precision in customer targeting, thus drawing in more advertising dollars to their platforms. Furthermore, according to eMarketer, iResearch, and Morgan Stanley Research, as of January 2018, China’s social media now accounts for a mere 9% of the nation’s digital advertising spending, which is significantly lower than the 25% in the US. This allows further room for the Internet giants to monetize their social media offerings. Given their enormous growth potential, we believe that the Internet stocks’ current valuations are justified.
Having said that, to abide by our selling disciplines, we don’t rule out taking profit on some of our holdings when their prices hit their targets. After all, our investment philosophy is centered on “seeking growth at a reasonable price.” For a stock to be included in our portfolio, it must beat the market’s average earnings growth and have valuations at a decent and not expensive level.
BM: A deeper look at your fund’s sector allocation revealed a cautious stance on financials. Why?
KK: We are underweighting the financial sector because of a mixed bag of concerns. From the perspective of subsectors, we approach banks, brokers, and property developers with caution.
In China’s banking sector, the tightening interbank funding and the subsequent increase in funding costs, leads to the narrowing of net interest margin in small sized banks, which highlights our cautious views on banks. In the property space, policy tightening has ushered in a consolidation in the industry, helping large developers gain market shares. While this bodes well for their profitability, deleveraging may again constitute a drag. Lastly, we expect Chinese brokers to stay under pressure as keener competition squeezes margin. Also, the plateauing trading volume in Asia is not working in their favor, either. Therefore, a watchful eye is warranted.
BM: Let’s talk politics. What kinds of political risks should we be aware of in China this year?
KK: As the dust of the leadership reshuffle has settled after the 19th Party Congress, we expect an accelerated pace of economic reforms in China. From the authority’s rhetoric, it is clear that deleveraging and financial risk controls will be China’s policy focus this year. Considering that the growth of national debt is still outstripping GDP, we believe that stepped-up risk controls are necessary for China to herald in a healthier, higher quality growth, although they may weigh on the market in the short term.
BM: You just mentioned China’s reform. What are your views on the state-owned enterprise (SOE) reform?
KK: The SOE reform is a multi-year process whose merits are yet to be fully priced in. That’s why uncovering profit opportunities in China’s reform story remains our key focus. In the recent years, we have been seeing a widening scope of SOE reform initiatives. In particular, streamlining corporate structures and disposing periphery businesses to parents or affiliated companies – so that SOEs can redirect their attention to their core businesses – are becoming the focal points of the reform. Some of the reform initiatives are nearing harvest time, as evidenced by the marked improvement in earnings. We’re definitely witnessing more opportunities engendered by the SOE reform today than a few years ago.
BM: Besides China’s reform progress, the US rate hike is also among the chief concerns in the Hong Kong market. Do you think these worries are rational?
KK: Yes, we share investors’ worries that interest rate hikes may hinder the financial health of high-gearing companies and companies heavily investing in US debt. Moreover, high-dividend plays, which were once well sought after in the low interest rate environment, are lacking momentum, too. Sensing the looming rate hike cycle, we have already trimmed our exposures to these sectors.
BM: Lastly, can you tell us what other external uncertainties are under your radar?
KK: In terms of external risks, the policy direction of the US administration remains the biggest wild card. In the early months of Trump’s presidency, the market worried that the new president may slap heavy tariffs on China, and these worries are now returning. To start with, a steep tariff on imports of washing machines and solar panels has been imposed, and investors are jittered by potential retaliatory actions by China. While the impact of such events shouldn’t be overplayed, we will continue to closely monitor how the escalating trade dispute unfolds. BM