As the name suggests, the award winner Value Partners (VP) is focused on finding value stocks. Having spoken with Philip Li, Senior Fund Manager, it’s clear to see just how strongly it follows this principle that leads to the team’s investment success.
The investment house has been in business for more than two decades and in that time has created a strong culture for itself of seeking out unloved and out-of-favor stocks. The firm also avoids hiring egos within the management team which leads to a more stable and harmonious set-up, while upholding an admirable no-blame culture.
Eyeing for Gems
The team aims to identify high dividend stocks that focus on businesses with the ability to pay dividends and paying dividend more than once a year. “We like companies with strong cash flow from operations which reflect a higher quality of earnings. We also focus on businesses with the willingness to pay dividends, which means management’s incentives are aligned with the investors by returning profits to shareholders in the form of dividends”, says Li.
The firm is particularly interested in businesses with a reasonable gearing level, and stable earnings, which offers a more predictable level of profitability and potentials to increase dividend payout in the future. It generally avoids high growth companies which generate less cash flow, or highly geared companies with limited ability to pay dividends from their thin margins. On the same token, the team believes companies with a high payout ratio is not likely to be sustainable, same with companies with poor management quality.
The team’s internally-generated research covers thousands of stocks in Asia Pacific with less than 2% of the top ideas ended up in their portfolios. Li explained how value investing involves a lot of legwork. ‘’The thinking is we need to be on the ground, we need to see the companies, we need to discover the value where other people haven’t looked at. It could be an information advantage or a more in-depth knowledge, and hence, that is an advantage for ourselves,’’ he says. When VP look at stocks that are cheap (usually on a P/E basis), they are often out of favor among investors and hence undervalued.
Looking under the hood
But isn’t there a danger in picking undervalued stocks that never actually realize their true value? ‘’I think the magic is pushing everyone to think outside the box. That’s why we are not being distracted by circuit-breakers and other market issues. Instead, we tend to focus on the fundamentals. If the fundamentals are improving for a company and they are very cheap then that’s an attractive buy,’’ he adds. It currently sees a lot of value within financial, property and industrial companies. While it notes that these sectors have consistently underperformed, there is still plenty of unlocked value within them.
When it comes to investing in small caps in emerging markets such as China and India, the challenge is that transparency can be little. So VP insists on visiting every company that it invests in. ‘’On top of that is what we call a 360-degree view. When we like a company we tend to look at its competitors and its peers, and they always have something good or bad to say. That ultimately gives us a 360-degree view of a company, and that’s why we have an enormous team, with over 65 investment professionals,’’ he explains. With so many experienced members looking into a company, from their suppliers to their clients and their peers, allows VP to garner a much better flavor about their business. ‘’Obviously, there will be ways we could get more factual information, such as sudden visits where they may not roll out the red carpet for you without planning weeks ahead,’’ he adds.
To hammer home this level of diligence, VP also does a lot of cross-checks. “For example, our team may phone the company up and pretend to be a customer, checking on availability of the different colors of an automobile. If all the different colors inquired about are in stock, it probably indicates that there’s something wrong about demand. Different anecdotal points will give us more accurate picture about of forecasts or the company’s earnings”, he explains.
A lot of the times when VP visits companies it is looking for red flags, trying to uncover any issues behind the rosy story it may paint. Apart from questioning the chairperson or the CEO of a company to see if they are guarded in their answers, Li also has a long list of question he will need to find answers for a detailed step-by-step analysis. ‘’For example, are there a lot of inventories sitting around when you visit their factories? Are there a lot of people waiting around not doing anything? If they say there’s a massive backlog of orders, do you see the factory producing 24 hours a day?’’, says Li. Talking to the companies’ clients might also help discover some truth, such as randomly large orders, whether it’s due to destocking or significant price cuts. ‘’A business is very simple, they have revenues, they have costs. Once we go down line-by-line there is tiny to hide,’’ he states.
VP consistently wins plaudits for having funds with lower volatility than its peers. ‘’There is no magic to this or a guarantee formula. The key thing is to have a disciplined value system. When we buy stocks that are cheap, we think that there is a vast margin of safety that they are much lower than what people think they should be valued. So if you’re buying things that are cheap to begin with, if the market sells off or expectations are not met, that downside tends to be lower. That’s the style of a value stock,’’ he explains. Liquidity is also one of the important factors in managing risks, he says, and according to Value Partners, 88% of the firm’s portfolio can be liquidated within 20 business days.
The recent trimming of Hyundai’s stocks demonstrates the firm’s prudent approach to exposures that have clear corporate governance risks, such as Korea. The firm decided to exit the stock after Hyundai bought a piece of land three times its appraised value, indicating a poor use of capital and corporate governance.
But the investment house also comes under criticism at times for having higher expense ratios for its funds. ‘’All of our performance is net of fees, so there is no hiding of those costs. We have significant deviations from the benchmark, so we need a large team to look at those small and medium caps and out of favor stocks. That is part of where we invest to get better returns,’’ he justifies. And the strategy is paying off for investors as VP continues to seek out undervalue stocks with substantial turnaround stories.
The firm’s efforts show in their performances with their flagship high dividend strategy fund, Value Partners High-Dividend Stocks. Over the past ten years to 31 October 2015, the fund ranked in the top percentile among peers and outstripped the MSCI AC Asia ex-Japan Index and MSCI AC Asia ex-Japan High Dividend Yield Index by 434 basis points and 195 basis points per year respectively. Volatility (as measured by standard deviation) has also been consistently lower than peers and the category benchmark during this period. The fund’s turnover has been about 50% to 70% per year, which means on average the managers hold a position for around two years. The fund has up to 100 positions and the top 10 stocks representing roughly about 30% of the portfolio.
Li thinks for 2016, the uncertain situation is very much one of caution which has led VP to hold a cash portion that is higher than usual. But he believes there are still a lot of value in the market. With the recent retreat in the stock markets, say the Hang Seng China Enterprise Index, the average P/E is less than 5x, making it the second cheapest in the world. He continues to like China, Hong Kong and Korea, where markets were down by double digits last year valuation is now a bargain. Li finds tiny interests in ASEAN except Indonesia, which currency he finds has less room to adjust downwards. BM