Value Partners talks to BENCHMARK about its investment process and outlook on corporate high yield.
BENCHMARK (BM): Please explain how investments are selected and describe your valuation model.
Philip Li Yee Lap (PL): The firm adopts a strict bottom-up selection approach focusing on dividend yield, with non-benchmark country allocation. With an emphasis on initiating original research, our co-chief investment officers, fund managers and analysts make more than 2,500 company visits and research meetings each year. Company meetings and due diligence research enable our investment team to gather enough information to work out in-depth analyses.
Value Partners uses valuation models constructed by our investment teams because we believe there is no single model that can be applied to all industries. When we identify high-dividend stocks, we focus on businesses with the ability to pay dividends, such as those with strong cash flows from operations. We also focus on businesses with the willingness to pay dividends, which means management’s incentives are aligned with investors to return profitability to shareholders in the form of dividends. Additionally, we are interested in businesses with stable earnings, which have a more predictable level of profitability and a not-too-high gearing level. Last, we look for businesses that do not pay too much, meaning the company has the ability to further increase dividend payout in the future.
BM: Where do you still find valuable and attractive dividend paying companies and which sectors seem to offer those opportunities the most?
PL: Our high-dividend stocks fund is invested across all market caps. In terms of geographical focuses, at least half of the fund is invested in Hong Kong and China stocks. We see yield opportunities in consumer discretionary, property stocks and bonds.
Consumer discretionary is a sector that we prefer, as China is seeking to become more reliant on domestic consumption for economic growth. As such, consumption remains a growing sector as wage growth and quality of life improve for the population. Our focus is in mid-income brands and companies that will benefit from the upgrade in consumption trends.
Meanwhile, we also invested in Korean stocks or, more specifically, preferred stocks. They offer attractive returns because preferred stocks usually trade at a hefty 15% to 65% discount when compared with ordinary shares of the same company. As a result of the discount, the shares are generally purchased at a lower cost and thus deliver a slightly higher yield. In 2013, preferred shares of Hyundai Motor significantly outperformed the company’s ordinary shares.
BM: What is the average number of holdings and turnover? What triggers them? Are there holding constraints for positions’ sizes or sectors?
PL: The fund has an average of 80 to 100 holdings. We have capped the maximum percentage of each holding to 10%, though we don’t impose limits on the total holdings of a particular sector.
Turnover ratio of our fund was historically around 100%. On the core holdings, we normally adopt a buy-and-hold strategy. If the price of an investment becomes more in line with its fair value, in most circumstances we will take profit and look for other deep value opportunities. Turnover has been higher in recent years because of increased market volatility.
BM: With an impressive downside capture ratio of 73.10% against the high-dividend yield index, what is the fund’s approach in managing during market downturns? What were the drivers for performance?
PL: We are flexible in adjusting our fund when there are changes in the macro-economic environment. In times of market downturns, we utilize cash or hedging strategies to fine-tune the risk of the fund. For example, cash position of the fund climbed to around 20% in the third quarter of 2008 after the global financial crisis erupted. The portfolio has been maintaining a low level of cash to remain well engaged in high-yield equity investments.
Value Partners has a seasoned investment team with 42 investment professionals with an average tenure of over 10 years with the firm and an average tenure of over 14 years in the industry. Our experienced investment team and the discipline in upholding value investing have enabled us to invest in the right businesses, run by the right people and at the right price, delivering strong fund performance.
BM: Please explain how duties are shared among team members managing a tight portfolio and a specialized series. How are macro calls made? How are professionals assigned to fixed-income, sectors and strategies?
PL: Our high-dividend stocks fund, as well as our other investment funds have a portfolio leader that oversee the portfolio, ensuring it is set up and managed in line with its investment restrictions. The portfolio leader is also responsible for deploying cash if inflows are received or raising cash for redemptions. We adopt a team-based approach and, therefore, the portfolio leader typically does not significantly influence the decision of what stocks are invested into the fund.
While the majority of investment ideas are generated from bottom-up stock selection, the team also adopts a macro overlay to protect the portfolio, especially in times of market stress. Our co-CIOs, Dato’ Cheah Cheng Hye and Louis So, with input from senior fund managers, are responsible for overall portfolio asset allocation by changing the portfolio’s cash level and the level of portfolio hedging. They have a wealth of experience in Asian-market investing and a strong acumen for market directionality through constant monitoring of bottom-up company performance and macro news flow. They determine the overall risk level or beta of the portfolio.
BM: What is your outlook on corporate high yield for 2014 and which countries are likely to benefit from this current interest-rate environment?
PL: We see opportunities in the corporate high-yield market in 2014, particularly in Chinese high-yield bonds, as they are trading at a premium against US high-yield bonds. Investment in this sector is a key driver for our portfolio in 2014. We will continue to use our core bottom-up bond picking strategy to acquire Greater China and other Asian high-yield bonds, as well as holding some Japan convertible bonds.
Meanwhile, one of the biggest risks we see in 2014 is the miscommunication by the Fed or misinterpretation by investors on the timing and magnitude of QE tapering. Either error could trigger a re-pricing of risks and heightened market volatility. Dwindling fund inflow into emerging markets could potentially weaken demand, although it is partially mitigated by the regional demand within Asia. Meanwhile, treasury yield will rise as the US raises the Fed funds rate, posting a negative impact on investment grade bonds. Yet, we believe the impact on spread products, such as high-yield bonds, would be minimal. In our view, it’s unlikely that the Fed funds rate will rise in 2014. BM
Philip Li Yee Lap is a fund manager at Value Partners Limited. Li joined Value Partners in May 2010 and is involved in various aspects of the company’s investment processes and operations, including investment research and investment team communications. Prior to joining Value Partners, Li was a portfolio manager at GAM, overseeing managed portfolios and marketing to Asian clients. He previously worked at Alliance Bernstein and INVESCO in various portfolio management and marketing roles. Li graduated from the University of Michigan with a Bachelor of Business from the Stephen M. Ross School of Business in 2003. He became a CFA charter holder in 2007.