Value Partners Classic Fund Third Quarter 2013 Commentary
China has been one of the worst performing major equity markets since 2007. But we believe the Chinese stockmarkets bottomed out in the first half of this year. Chinese stocks, in terms of forward price-to-earnings ratio, are trading at only around 7 times, close to the lowest level over the past five years. Still, there are indications that economic growth have turned the corner with the official manufacturing purchasing managers' index (PMI) for September edging up to 51.1, while the non- manufacturing sector index rose to 55.4 – the highest reading in six months. From our on-the- ground research, we observed anecdotal evidence that exporters have seen growth pick up as external demand improves. We believe a recovery is already under way.
Curtain rises on reforms
The recovery – seen after Chinese Premier Li Keqiang set a 7.5% "growth floor" for the economy in July – has helped boost market confidence and made room for policymakers to refocus on reforms. In the quarter, the Chinese government started to lay out a host of reform measures to address structural issues, covering lending rate liberalization, set-up of privately-owned banks and consumer credit companies by private investors, as well as opening up of the health care industry to private and foreign investors. These are just some of the minor steps that will culminate in significant changes, and precursors to a milestone development announced by the end of the quarter: Shanghai's pilot Free Trade Zone (FTZ).
This free trade zone, the first in China, signifies a round of new reforms and opening up. It has the mandate to spearhead reforms and develop a new governing model that can be adopted by the whole country. Its impact will likely be comparable to the establishment of the Shenzhen Special economic zone back in 1980. The sheer speed of the approval process of the free trade zone – green lighted in just six months – demonstrates the new government's determination and urgency to push through reforms. While details remain to be ironed out, profound steps will be taken to drive financial liberalization (such as entry liberalization, free setting of interest rates and RMB capital account opening). We believe these will strengthen China's financial sector and boost the country's long-term growth outlook.
The Third Plenum
One of the much-discussed catalysts for the Chin a market is the third plenary session of the 18th Party Congress, slated for November. Policymaker s are expected to set the direction for further reforms in the next few years – a critical window for implementing changes. The government will make efforts to boost domestic demand, enhance productivity gains and reduce the country's debt level. A concerted wave of reforms will help China avoid the middle-income trap and move its economy up the value chain.
To fuel innovation, promote corporate governance and efficiency, the government is set to steer private sector development in industries currently dominated by state-owned enterprises (SOEs). Powerful deregulation initiatives allowing private firms to prosper (especially in the banking and utility sectors) will drive continued economic growth. Reforms on such a large scale take time to yield desired results, and short-term pain will be inevitable.
As a value investor, we will stay patient until harvest time. We will continue to identify companies that we believe to have high intrinsic value, which will likely benefit from the structural transformation over time. We see opportunities in the health care sector as China's aging population grows and the demand for medical services increases. In the consumption sector, we see strong growth potential for manufacturers of sport utility vehicles (SUVs). The penetration rate of SUVs is still low in China compared with developed countries, and there is potential for a multifold increase for select players in the coming years.
Another sector likely to benefit from reforms is energy. With deregulations to bring natural gas prices closer to global levels, major oil companies could see a jump in profits. While we observed share price correction for PetroChina (PTR), one of our conviction ideas, as the company recently saw its management members came under investigation by the Communist Party, we believe this could be an opportunity for the company to improve corporate governance, and the right direction to go in releasing value over the long term.
For China's property sector, we see the physical market is in a healthy state, supported by real demand (first-time home purchases and first-time upgrades) as the government promotes healthy and stable development of the property market. While the policy environment will likely remain stable, we cannot rule out the possibility of expanding the property tax scheme to include more cities later this year or next year. For the longer term, the government is expected to shift towards market-oriented measures, such as taxation, from administrative ones.
In realizing the "China Dream", the country's urbanization rate may reach 66% in 2030, meaning an increase in urban population of 300 million. This New Urbanization – aiming at helping migrants from rural areas to settle in a city over a longer term – spells strong support for housing demand in the next two decades. Subtle and intricate geographical and segmental differences in property projects mean great potential variance in the performance of developers. Our strong research capability plays to our advantage in our quest to pick those who are best positioned to benefit from strategic planning and strong execution in the vast land of China.
We are pleased that in the 2013 Asia Hedge Fund 25 – a survey of Asia's biggest hedge funds compiled by Institutional Investor's Alpha magazine – we are ranked No. 1 for the fourth consecutive year. As we continue to establish our presence as the Temple of Value Investing in Asia, we have been garnering more attention from global investors. We won, in the quarter, a mandate to manage a closed-end fund listed in the US, in an internationa l "beauty contest" among global asset managers.
Also worth mentioning is that Mr. Cheah Cheng Hye, our Chairman and Co-Chief Investment Officer, was conferred the title of "Dato' " – an honorary title that recognizes exceptional individuals – by the government in his home state of Penang, Malaysia in August 2013. (The title comes with the award of an honorary "Darjah Setia Pangkuan Negeri".)
Value Partners Investment Team
10 October 2013
Fund performance mentioned referred to Value Partners Classic Fund "A" Unit. All performance figures are sourced from HSBC Institutional Trust Services (Asia) Limited and Bloomberg (Data computed in US$ terms on NAV-to-NAV basis with dividends reinvested) as at 30 September 2013. Performance data is net of all fees.
Individual stock performance is not indicative of fund performance.
Investors should note that investment involves risk. The price of units may go down as well as up and past performance is not indicative of future results. Investors should read the explanatory memorandum for details and risk factors in particular those associated with investment in emerging markets. This commentary has not been reviewed by the Securities and Futures Commission. Is suer: Value Partners Limited.