Left: Yee Hou Seck, Senior Analyst/Portfolio Manager, Middle: Martin Lau, Director, Greater China Equities, Right: Quanqiang Xian, Portfolio Manager
First State Investments (FSI) excelled at the BENCHMARK Fund of the Year Awards 2012 taking home four of the Best-in-Class Fund Awards. The group’s success is no surprise, given its diligent investment approach. Each fund typically has three fund managers – a lead manager, co-manager and deputy manager – in an effort to minimize continuity risk. A team of thirty analysts backs the Asia Pacific/Global Emerging Markets’ management trio.
FSI’s focus on absolute returns, rather than relative returns, has led it to incorporate a robust buy-and-hold selection process into its funds. The group summarizes this process through the acronym QGP, which stands for quality, growth and price. Seck, who co-manages the group’s US$262.8 million First State Hong Kong Growth Fund alongside Lau, explains that the quality of a company’s management team is paramount. It also looks for quality in both a company’s business model and its financials. Third, the group looks for companies with sustainable, rather than explosive growth, which is why its funds have an investment horizon of between three and five years when picking stocks.
Finally, it looks for stocks with reasonable valuations, to ensure funds do not overpay. The group’s funds have highly experienced management teams, with those behind the First State China Focus Fund having an average experience of seventeen years and an average tenure of nine years. Those behind the First State Hong Kong Growth Fund have an average experience and tenure of sixteen years and twelve years respectively.
But financial metrics are just one of the ways that FSI’s managers evaluate companies, with the group also looking for firms with the “right” managers by getting to know these managers well. Xian explained that analysts have repeated meetings with managers of companies they are interested in to get a better picture of the firm. “We meet with senior management and chairpersons and we try to build a complete picture about a company’s culture,” he said. “Culture is part of the definition of quality in our opinion. And it’s not just the personality of one individual that is important, but the personality of a group of individuals.”
Lau points out that companies are driven by people and financial results are the end result of the decisions made by these people. As a result, understanding the behavior of decision makers is very important and the team spends up to seventy percent of its time visiting companies across the region. “We like people who are more conservative and risk-aware, especially in the case of China or Asia where people tend to just look at the positive side and focus on growing capacity,” Lau said.“We prefer to see that management thinks about the downside as well.” An important aspect of understanding the behavior of decision makers is knowing what incentives they may be in line to receive. Lau believes that having the right incentives in place drives positive behavior. But he adds that, in China, sometimes the incentives are too small, while in other cases, they are too high. “It’s really about finding the right balance between being motivated and aggressive enough, versus having the right risk attitude,” he said.
Attitude to risk
FSI pays close attention to risk. The group’s First State Greater China Growth Fund, which won Best-in-Class, has had the lowest downside capture ratios amongst its peers for the past five years.
“We encourage our team to look at risk from an absolute perspective – meaning risk is about losing money,” Lau said. By contrast, managers focus very little on relative risks versus the benchmark because historically the Greater China Index has been the most volatile.
Instead, they build a portfolio based on the absolute risk of individual stocks, looking at the risk/reward profile of eachcompany individually. Lau adds that having Taiwan in the First State Greater China Growth Fund, which had total net assets of US$699 million at the end of February this year, has also helped to reduce the overall risk. “As Taiwan is a more mature market, Taiwanese stocks offer a higher dividend yield. This makes Taiwanese stocks more defensive and hence a good complement to China,” he said.
The group does not look at whether its First State Greater China Growth Fund is overweight or underweight relative to the benchmark. Lau joked that it is “almost forbidden” to talk about it. But FSI’s bottom-up stock picking approach means it tends to be underweight in stocks that have a heavy weighting in the index. Lau points out that while banks make up forty percent to fifty percent of the index in China, the group does not think it should put this proportion of its clients’ money into banks, just because that is how the index is made up. Instead, one of the key focus areas over the past five to ten years has been domestic consumption, leading to a strong bias for domestic consumption related stocks in the portfolio. The First State Greater China Growth Fund looks at domestic consumption in a broader sense, including, for example, gas distributors in China. “We think they have a reasonably predictable cash flow as gas penetration will rise with rising incomes and as demand for cleaner energy sources increases,” Lau said.
China’s domestic consumption as a percentage of GDP is still low. Xian, who co-manages FSI’s US$274.1 million First State China Focus Fund, explains that historically, there has been a tendency for Chinese people to save, which has held back consumption. “But over time, the bigger issue has been rising property costs, medical care and education. People have had to spend more money on these things, rather than general consumption,” he said. But Seck points out that China is moving up the “value chain”, and this should help to boost consumption. “Right now China has six million graduates a year and rising,” he said. “Wages are also going up. Skill sets are improving.
China is starting to do R&D, becoming a knowledge based society. This is creating a virtuous cycle, where better jobs lead to better pay, which leads to more consumption.” Seck thinks moving up the value chain will also help China mitigate the impact of its declining working age population. “Another factor is that China is also moving manufacturing more inland, where costs and wages are lower, but also, where the workforce is more stable,” he said.
China has faced periods of high inflation in the past and the group remains mindful of the issue. Xian points out that, in an emerging market like China, people still have a sense of insecurity when it comes to the supply of goods. “This is a risk that the government is very sensitive to,” he said. “So I think, in the years to come, the government will implement rounds of anti-inflationary measures if they see issues with the supply
of products, including property.”
The government in Hong Kong recently stepped in to cool property prices by implementing a further stamp duty on foreign buyers. The First State Hong Kong Growth Fund, which won Best-in-Class, has historically been overweight in Hong Kong financials and real estate. Lau explained that, for the past five years, the fund has held a positive view on Hong Kong property prices, due to negative real interest rates and the export of capital from China.“This has panned out well over the past few years,” he said. “But now everyone is aware that there is a bubble. Our stance is that, at this juncture, it’s too dangerous to add on to our property exposure and it would be prudent to reduce exposure over time.”
FSI also sees bank debt and general borrowing levels in China as a significant issue. Xian explains that banks have been the main funding channel for Chinese companies over the past thirty years, with the stock market still playing an insignificant role among firms wanting to raise capital. The 2008 RMB4 trillion stimulus by the central government was also expanded to about RMB10 trillion at the local level through bank lending. As a result, Xian thinks bank credits remain significant. “The way going forward has to be deleveraging,” he said. But Xian adds that household debt is low and many listed companies have raised significant levels of cash from the quick economic recovery in the past few years. “Therefore, the area to watch out for is the debt levels at the local government level,” he said.
The group is committed to socially responsible investing through its environmental, social and governance practices framework. It pointed out that this framework is not only about making charitable contributions, but also looking at how companies generate wealth. Xian said, “It’s important to see that companies generate profits in an ethical and socially responsible manner, rather than making money in an undesirable way. When it comes to governance, we want to see that there are checks and balances on the board.” The requirement for companies to be ethical extends to how they treat their employees, with FSI paying attention to how employees are paid and what their work environment is like when they visit companies. Lau said, “Investment is not just about making money. We believe there should be principles when deciding in which companies to invest. For example, as a team we decided that we should not invest in tobacco companies, as we think there are better ways of making money instead of threatening people’s health.” BM
今年，首域的投資團隊再次贏得多個獎項，涵蓋亞洲股票、中國股票、香港股票及新興市場股票類別。此外，首域亞洲股本優點基金(First State Asian Equity Plus Fund)及首域印度次大陸基金(First State Indian Subcontinent Fund)獲得同級最佳的殊榮，而首域大中華增長基金(First State Greater China Growth Fund)則贏得「傑出表現獎」。