First State Greater China Growth Fund was added to the Foundation Fundlist, our preferred investments across the major sectors, in August 2016. It had long been one of our Collective Research Team’s highest conviction ideas for exposure to Chinese equities, and having recently re-opened to new investment we were keen to add it to the list.
Run by Martin Lau, the fund is managed using First State’s long-established and successful investment process looking for high quality, well managed companies that look after the interests of minority shareholders. There is a strong emphasis on long term investment decisions and capital preservation; though it is inevitably a volatile area to invest.
Mr Lau notes there is more choice than ever for investors in Chinese equities. There are around 4,000 Chinese listed companies, including those traded in Hong Kong and the US. Yet the area that is seeing the fastest growth in new listings is on the Chinese mainland, also known as the A-share market. Historically this has been a highly volatile place to invest, even in the context of emerging markets, and highly susceptible to rapidly-changing investor sentiment. However, Mr Lau believes valuations are undemanding at present and that among the 3,000 companies that make up the mainland markets there are some outstanding opportunities.
Underlining the importance of being selective, the manager explains that A-share companies’ returns on investments have been on a declining trend for some time, and on average is little higher than the cost of borrowing. This is a disappointing picture for investors, potentially made worse by some companies’ returns being flattered by the use of financial products as opposed to investments in their core business. His approach is to solely focus on companies with strong sustainable returns, differentiated products and whose management show integrity and a keen eye on risk management.
Mr Lau explains this narrows down the field quickly, and that he monitors just 100-200 of the thousands of A-share companies available. Yet with valuations inexpensive and the potential to find industry leaders in sectors such as consumer goods, an increasing number of these are making it into the portfolio. For example, electrical appliance manufacturer Gree Electric, medicines firm Jiangsu Hengrui and coach and bus supplier Yutong Bus. Overall, the proportion of the portfolio invested in A-shares has risen to 17% from below 10% a year ago.
A further theme in the portfolio is healthcare stocks, which Mr Lau expects to benefit from higher welfare spending. Interestingly, a key holding in this area, CSPC Pharmaceuticals illustrates some of the progress being made in the reform of State-owned companies. Previously the firm concentrated on the bulk manufacture of basic drugs, but following a management buyout spending on research and development was increased, which resulted in a range of more specialist products that improved earnings and margins. Mr Lau is confident the company will continue to do well, not least because of the fragmented nature of the Chinese healthcare industry, which he believes should consolidate over time to the benefit of more dynamic firms.
With a portfolio orientated towards the domestic Chinese economy this fund may perform rather differently to the wider Chinese markets where large manufacturing exporters and resources firms are more prevalent. This can mean missing out on returns when these areas are in the ascendancy; although in the shorter term it may mean the fund is less vulnerable to any protectionist policies emanating from the US, as well as any appreciation of the Chinese currency. We continue to admire the manager’s rigid focus on identifying strong companies with good quality management in a region where there are many pitfalls for investors. It remains part of our Foundation Fundlist.
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