Fondi&SICAV

Dawid Krige, advisor of the Banor Sicav Greater China Long Short Equity, interviewed by Fondi&Sicav on China.
Read the full article below.

CHINA, THE PYTON ATE TOO MUCH. 
China’s current debt situation can be compared to a python that has just had a heavy meal which it now needs to digest before it can go hunting again. Likewise China will require time to digest its recent debt binge but the government has a number of tools to stimulate the economy and China is still the fastest growing major economy.

What is your investment approach to the Chinese market? We name our investment philosophy Quality Value. It is very simple: we buy great companies when they are significantly undervalued. A great company is one with durable entry-barriers, and honest and capable management. There are relatively few companies in Greater China that meet our criteria: our target universe is about 150 companies out of a total of 5,000 or so companies we could invest in. Of these 150, we typically own around 20 that are undervalued based on their forecasted cash operating earnings. We are essentially applying Warren Buffett’s investment principles in Greater China.

What are the themes that have worked out best, and which ones did not work out in your portfolio during 2015? Our investments in financials and companies that have been hit by the anti-corruption campaign, such as the high-end spirits companies Kweichow Moutai and Wuliangye, have performed strongly in the first part of the year. Names that have been under a bit of pressure include our exposure to retailers such as Luk Fook, the Hong Kong jeweller.

How would you read the recent economic data coming from China, especially at manufacturing level? Is the country going through a so-called hard landing? Despite market volatility and sensational newspaper headlines, not that much has changed in China over the past few months. Domestic consumption of goods and services remains buoyant, while investment and exports remain subdued. Our view has always been that slower Chinese growth is inevitable, partly because of a bigger base and partly because 10% growth has led to various imbalances in its economy.  Talk of a hard landing was popular a few years ago; it didn’t transpire then and we don’t think it is going to transpire now, mostly because the government has a number of tools to stimulate the economy.Of course, growth is slower today than it was a year or two ago. And like most others we are skeptical of the official figure of 7%. Something like 5% is probably closer to the truth, judging from companies’ results and from our discussions with companies and people on the ground in China. But this would still make China the fastest growing major economy in the world.

Some economists watching from abroad believe that the country is in the midst of a financial crisis because of the excessive debt burden it incurred in recent years. What is your opinion? We share the view that China has taken on too much debt too quickly in recent years. The bulk of this debt sits with local government and with certain state-owned enterprises. Interestingly, the central government, Chinese consumers and many listed companies have strong balance sheets. For example, the typical holding of the Banor Greater China fund has hardly any debt and net cash equal to c. 10% of its market cap. China’s current debt situation can be compared to a python that has just had a heavy meal which it now needs to digest before it can go hunting again. Likewise China will require time to digest its recent debt binge. If it wants to do so quickly and without “indigestion”, it needs to continue growing. On this score we remain optimistic: coming off a low base, China has the potential to maintain GDP growth above 5% for the next 5-10 years. Regardless of how quickly China addresses its debt and other issues, we believe the risk of an imminent financial crisis is low: firstly the government is popular and most of its policies are sensible; secondly it controls every major financial institution; thirdly it is willing and able to support the economy through monetary and fiscal stimulus; fourthly the presence of exchange controls makes large-scale capital flight unlikely.

What is your assessment of the Yuan devaluation? We believe the Chinese central bank did the right thing given that the currency had appreciated by 14% over the previous 12 months on a trade-weighted basis. However, its timing and the way it was communicated could have been better. Looking forward, we don’t expect large scale depreciation of the currency as it is fairly valued and the Chinese government prizes stability more than anything else.

Is China at risk of a prolonged capital flight process? With what consequences? We don’t think so. It is only natural for Chinese savers to diversify by investing outside of China now that they can do so. But foreign businesses continue to invest in China, especially for the production of higher value added products. And while China is today the world’s second largest economy (15% of global GDP according to the IMF), it still represents only 3% of global stock market indices! Over time, it might become 20% or even 30% of global GDP. Its global importance is likely to be recognized in investors’ portfolios sooner or later.

What are today the most reliable pockets of strength in the Chinese equity market? Demand for consumer products and services such as healthcare, leisure, the internet and tourism remain robust. Interestingly, this is also where we see some of the best long term growth potential. For example, China’s per capita healthcare consumption is about 1/30th that of the US. With supportive government policy and an ageing population, the sector is likely to enjoy a multi-year tailwind. We are also excited about the potential impact of economic reforms. It is a broad topic and implementation is likely to proceed slowly, but the long term results should be twofold: more stable, consumption-driven growth, and a greater role for private enterprises. Some of the major areas include addressing ownership rights of individuals, loosening the one-child policy, opening up of certain industries to private players, and liberalizing interest rates and the capital account. Some of the fund’s holdings such as the two asset managers Noah and Value Partners are direct beneficiaries of some of these trends. We are positive about the new Chinese leadership’s reforms. State-owned companies will be made more shareholder-friendly and 100m migrant workers will be provided with healthcare and other social benefits. Other major reforms include liberalizing of interest rates and opening up of certain parts of the economy to private capital. Generally speaking, these reforms will be positive for domestic consumption and allow for capital to be more sensibly allocated in future.

What is currently the main risk for China? The major risk for investors in China is if economic growth were to collapse. However, we wouldn’t put a high probability on this happening given the size and the strength of its domestic economy, as well as the number of levers available to Chinese policymakers.

 


The contents provided for in this section have not been audited by independent bodies. There’s no warranties, expressed or implied, regarding reliability, accuracy or completeness of the information and opinions contained. The informations provided are not based on assessment of the adequacy and do not consider the risk profile of the possible recipients, and therefore, should not be construed as personal recommendation and does not constitute investment advice. The contents of this site may not be reproduced and/or published whole or in part, for any purpose, and/or disclosed to third parties.