The culture there at Principal Global Investors is also about teamwork, system and discipline while taking emotions completely out of the equation. Award winning manager for the Greater China Equities, Alan Wang, shares with BENCHMARK how he aligns investors’ interests with his own pensions.
Principal’s screening process must be one of the most intense in the investment industry, using more than 400 different characteristics to assess a stock.
The process helps the investment house to focus on three main areas when it comes to stock-picking: business fundamentals, rising investor expectations and attractive relative valuation. It is an investment process the group has had for more than a decade and continued to serve it well.
Talking about where it is finding improving fundamentals, Alan Wang, fund manager of Principal’s Hong Kong Equity Fund, says: ‘’We like the new economy sectors. It has been the case for the past few years that the earnings trend has been much better for the new economy which is technology, consumer, and media. What we have identified are widening margins in these industries or turnarounds. We like the space where capacity has been reduced and a company has much stronger pricing power compared to its peers. These are improving fundamentals for the whole industry’’.
A unique edge Principal has compared with the sector is its proprietary Global Research Platform (GRP) and infrastructure which helps it to focus on the companies that tend to outperform their peers. Every company is given a rank of 1 to 100 with 1 being the best and 100 being the worst. A company ranked 1 to 20, for example, is studied and visited earlier than one lower down the list. Site visits include face-to-face meetings with C-level management to ask them general questions about their strategy and the outlook for the industry.
The screening of these companies is impressive by industry standards. ‘’For every stock, we have customized data to look at more than 400 characteristics of a business that can impact its future share price or alpha versus the benchmark. We build concrete industry models to tell which company tends to outperform. Common sense plus quantitative infrastructure plus we use our study to forecast the future,’’ he explains.
If a company moves up the rankings, Principal needs to know where exactly it is getting better. ‘’If it’s just that the valuation is getting cheaper we would want to check if this is a value trap or not. In this market, a lot of small cap companies tend to look attractive, but they could be losing market share to industry leaders, and it will never come back. Our tools enable us to look into the details and see whether the trend is pointing to a recovery if it’s sustainable, and will it perform in both up and down markets,’’ he adds.
Interestingly, the US$3.2bn Hong Kong Equity Fund composite adopts a custom benchmark of 92% S&P BMI Hong Kong& China and 8% HSBC index. This combination opens up to a universe of more than 900 stocks, broad enough to allow Principal to leverage its systematic approach to looking at companies. From this, Wang and his team whittle it down to a concentrated portfolio of about 70 stocks, of which the top 10 holdings account of for 41% of the fund’s assets. For proving alpha, the fund manager prefers small and mid-cap stocks which he believes will outperform large-cap stocks over the long term.
But with this concentrated fund, Principal is careful to keep liquidity as high as possible, hence investing g the benchmark index. ‘’For the long run, the benchmark does generate excellent returns and gives you enough liquidity. If you are agnostic about the benchmark you can be very concentrated in certain hot sectors and stocks which will put you vulnerable when there is a huge liquidity outflowing,’’ he explains. Just like last year when liquidity shrank massively in Hong Kong, many concentrated funds were facing big redemptions.
The future of Hong Kong
Discussing Hong Kong as a city, Wang is very optimistic about its long-term attractiveness despite its recent political woes. ‘’It probably has the best talents and legal structure in the world and is still one of the most important financial centers in the world. China is becoming a stronger player in the world, and Hong Kong, as a financial center of China, will also become a more valuable player in the world,’’ he says. But its stock market has come under pressure from the lack of a shorting mechanism in A-shares recently. ‘’Hedge funds have to use Hong Kong to hedge their positions in A Shares because they don’t know whether the Chinese equity market can go up or not. If they want to take long positions and the Chinese regulator don’t like shorting on shore, Hong Kong has increasingly been used as a shorting mechanism. When things normalize I believe Hong Kong will have much better out-performance,’’ he predicts.
As for China, plenty of concern remains over it continued slowdown and its shift from manufacturing to a services-based economy. While investment and exports have been falling much faster than what consumer sector can offset, Wang still has an optimistic outlook. ‘’From the fourth quarter of last year, consumption has taken more than half of the economy, and that’s the exact trend the Chinese government is pointing. With the increased consumer sector and service sector, China is going to find the bottom at some point. We are just suffering from transitional and deleveraging pains,” he adds.
For the year ahead, Wang likes the technology, telecoms, and consumer discretionary sectors, followed by utilities. Most of these are from the new economy, leaving the fund underweight in the old economy sectors. As the new economy continues to take a bigger share of economic growth, the fund is agile enough to follow this shift quickly. One sector that has been on and off the radar is the gaming industry. ‘’For half a year we didn’t own any gaming stocks. Most of the time we have been underweight because we believe the government has not been favoring this segment,’’ he concludes. BM