Legg Mason focuses on Hong Kong, China leaders
The fund houseÆs Hong Kong and China specialist says sticking to companies with quality management is even more important now.
Crystal Chan is the head of Hong Kong and China Investments at Legg Mason International Equities. She leads a dedicated Hong Kong and China equities team, which manages money exclusively in those markets. The team operates as an independent and autonomous boutique investment manager within Legg Mason, which manages around $842 billion globally. She shares with AsianInvestor her views about the markets she is responsible for.
How are you preparing to take advantage of the investment opportunities in Hong Kong and China?
Chan: For Hong Kong and China markets, while we recognise that there are near-term risks from global credit conditions and further economic deteriorations and implications, we remain extremely positive on a medium and long-term basis as company level fundamentals are still robust and valuations are becoming very attractive. We are seeing great value in industry leader stocks that had not been seen for a long time. We believe that well-managed companies with robust balance sheet and cash flow are likely to benefit and be re-rated by investors first.
As with previous crisis, markets will continue to undershoot as stocks are being sold aggressively but we believe valuation û coupled with earnings certainty û is key during these uncertain times and focusing on industry leaders at or near their historical trough valuations will be a good start. We will continue to accumulate based our analysis, attractive undervalued winners emerging from current crisis.
How has financial turmoil affected your investment management style?
There hasnÆt been a significant change in the way we manage portfolios on the back of the global financial crisis as we take a longer-term view on stock valuations, coupled with a 12 months outlook on catalyst drivers for stocks. Stocks across the board are showing attractive value, however, most stocks are lacking the latter signal in terms of catalyst drivers in the next 12 months as corporate earnings certainty is not visible. We therefore, have been focusing on industry leaders who are more resilient in its earnings and who are also trading at discounts to our derived fair values.
What is the biggest lesson you have learned from the US credit crisis?
Given the large scale and sharpness of the current US-led credit crisis, this has led to a massive credit crunch and lack of available funding in global financial markets. We have seen in Hong Kong and China, corporate earnings evaporate as access to funding or working capital needs were difficult in this operating environment. Corporates with high gearing ratio and leverage levels are in scrutiny by investors and assessing their manageable gearing levels can be challenging during these times. We would stress that sticking to quality management with high transparency is ever more important during these crisis times.
What is your outlook on China?
We are very favourable on the outlook of the China market. ChinaÆs growing importance in the economic scene is more and more visible. For example, China currently only accounts for 6% of the worldÆs GDP nominal value and 2% of the worldÆs market capitalisation. At the same time, real GDP growth is happening faster than the world although it is expected to slow in the coming year. We believe the medium-term earnings outlook is directionally positive, driven by factors such as the economy as well as robust corporate earnings and improved management incentives. We expect ChinaÆs long-term economic growth to remain strong, in the range of 7-9% over the next 5 years.
Structural changes in the financial liberalisation, assets injections to listed companies, ownership diversification, deregulation and capital accounts liberalisation will lead to more efficient resource allocation and therefore provide the basis for earnings out-performance versus developed and many emerging markets economies. The growth of the middle class population at a faster pace than income growth implies significant investment opportunities throughout different sectors.
What are your favoured sectors?
We are generally positive on the outlook for a number of ChinaÆs industries. We are positive on the infrastructure sector on the back of strong demand growth driven by fixed asset investments and continuous urbanisation efforts. Within the infrastructure sector, we are particularly positive on the railway segment as the demand for railway investment has increased significantly over the past years due to strong economic growth and transportation bottlenecks. We are also witnessing ongoing urbanisation and ambitious expansion plans by the government in this segment.
China has also been under-invested previously in this sector and would need to speed up its expansion plans to meet its stated targets. We also remain positive on China property sector given longer-term structural demand for home ownership as well as governmentÆs support for good property developers and affordable low-rent housing projects. We see attractive valuations given sector pullback.
Although there are near term overhangs from government policies but we view current levels as attractive. We remain positive on banking sector in the coming year as we expect further trade activities to pick up as the government is encouraging higher loan quotas as well as providing sufficient credit support for services and trade industries. At the same time, we do not expect non-performing loans to deteriorate substantially while earnings are still robust. We are also positive on certain sub-segments within the consumers sector on the back of higher quality of living and governmentÆs support to encourage domestic consumption.
Which sectors are you bearish over?
We believe that Hong Kong banks will continue to underperform as sector outlook remains challenging given the interest rate cycle as well as ongoing liquidity crunch in the system. We also expect Chinese telecom sector to underperform in the coming year as sector restructuring has been announced and it will take time for the operators to execute and realise the restructuring synergies. We believe that the restructuring is positive for certain operators in the long term and valuations of current operators are attractive but would expect sector to underperform in the next 12 months.
What are the main challenges that you expect to face in the coming 12 months?
The global financials sector has been struggling to contain the ever-increasing sub-prime led problem leading to waves of massive re-capitalisation actions, bankruptcies and mergers. These transformations are still ongoing. Unprecedented global coordinated responses from financial institutions, regulators and central banks have finally shown some initial success in stabilising the sharp deterioration in global financial system and eased accentuated interbank rates.
With increasing participation by governments in recapitalising financial institutions, confidence in interbank lending has progressively returned. The extent or magnitude of a global economic recession emerging from the financial and credit losses and the spread of credit crunch is still in question.
We still have to monitor whether there will be any large scale financial institution bankruptcies resulting from this severe financial and real economic crisis. Whether or not financial authorities are able to manage and contain a crisis of this magnitude still needs to be challenged over the next few quarters.
What are the main risks of investing in Hong Kong and China?
The real economy has begun to experience the full force of the impact from current global financial crisis. Proactive responses from central banks and government will continue to be needed to minimise these negative impacts. Downward revisions in key macroeconomic drivers for 2009 such as industrial production, inflation, interest rates, private consumption and employment are already partially reflecting such changing outlook.
Unavoidably, 2009 economic growth for both China and Hong Kong is also being revised down. China may even temporarily ease below the much needed 8% p.a. growth on a quarterly basis. To mirror this macro economic outlook, earnings expectations are also being revised downwards. We remain vigilant to these impacts on companies in Hong Kong and China. While equity markets will remain volatile further heightened by sporadic fund flows, quality large-scale companies with resilient balance sheets, cash flows and well-observed corporate governance should be consistent outperformers under current uncertainties. We maintain our bottom-up stock selection strategy taking into consideration both valuations and near term catalysts.
How are you preparing to take advantage of the investment opportunities in Hong Kong and China?
Chan: For Hong Kong and China markets, while we recognise that there are near-term risks from global credit conditions and further economic deteriorations and implications, we remain extremely positive on a medium and long-term basis as company level fundamentals are still robust and valuations are becoming very attractive. We are seeing great value in industry leader stocks that had not been seen for a long time. We believe that well-managed companies with robust balance sheet and cash flow are likely to benefit and be re-rated by investors first.
As with previous crisis, markets will continue to undershoot as stocks are being sold aggressively but we believe valuation û coupled with earnings certainty û is key during these uncertain times and focusing on industry leaders at or near their historical trough valuations will be a good start. We will continue to accumulate based our analysis, attractive undervalued winners emerging from current crisis.
How has financial turmoil affected your investment management style?
There hasnÆt been a significant change in the way we manage portfolios on the back of the global financial crisis as we take a longer-term view on stock valuations, coupled with a 12 months outlook on catalyst drivers for stocks. Stocks across the board are showing attractive value, however, most stocks are lacking the latter signal in terms of catalyst drivers in the next 12 months as corporate earnings certainty is not visible. We therefore, have been focusing on industry leaders who are more resilient in its earnings and who are also trading at discounts to our derived fair values.
What is the biggest lesson you have learned from the US credit crisis?
Given the large scale and sharpness of the current US-led credit crisis, this has led to a massive credit crunch and lack of available funding in global financial markets. We have seen in Hong Kong and China, corporate earnings evaporate as access to funding or working capital needs were difficult in this operating environment. Corporates with high gearing ratio and leverage levels are in scrutiny by investors and assessing their manageable gearing levels can be challenging during these times. We would stress that sticking to quality management with high transparency is ever more important during these crisis times.
What is your outlook on China?
We are very favourable on the outlook of the China market. ChinaÆs growing importance in the economic scene is more and more visible. For example, China currently only accounts for 6% of the worldÆs GDP nominal value and 2% of the worldÆs market capitalisation. At the same time, real GDP growth is happening faster than the world although it is expected to slow in the coming year. We believe the medium-term earnings outlook is directionally positive, driven by factors such as the economy as well as robust corporate earnings and improved management incentives. We expect ChinaÆs long-term economic growth to remain strong, in the range of 7-9% over the next 5 years.
Structural changes in the financial liberalisation, assets injections to listed companies, ownership diversification, deregulation and capital accounts liberalisation will lead to more efficient resource allocation and therefore provide the basis for earnings out-performance versus developed and many emerging markets economies. The growth of the middle class population at a faster pace than income growth implies significant investment opportunities throughout different sectors.
What are your favoured sectors?
We are generally positive on the outlook for a number of ChinaÆs industries. We are positive on the infrastructure sector on the back of strong demand growth driven by fixed asset investments and continuous urbanisation efforts. Within the infrastructure sector, we are particularly positive on the railway segment as the demand for railway investment has increased significantly over the past years due to strong economic growth and transportation bottlenecks. We are also witnessing ongoing urbanisation and ambitious expansion plans by the government in this segment.
China has also been under-invested previously in this sector and would need to speed up its expansion plans to meet its stated targets. We also remain positive on China property sector given longer-term structural demand for home ownership as well as governmentÆs support for good property developers and affordable low-rent housing projects. We see attractive valuations given sector pullback.
Although there are near term overhangs from government policies but we view current levels as attractive. We remain positive on banking sector in the coming year as we expect further trade activities to pick up as the government is encouraging higher loan quotas as well as providing sufficient credit support for services and trade industries. At the same time, we do not expect non-performing loans to deteriorate substantially while earnings are still robust. We are also positive on certain sub-segments within the consumers sector on the back of higher quality of living and governmentÆs support to encourage domestic consumption.
Which sectors are you bearish over?
We believe that Hong Kong banks will continue to underperform as sector outlook remains challenging given the interest rate cycle as well as ongoing liquidity crunch in the system. We also expect Chinese telecom sector to underperform in the coming year as sector restructuring has been announced and it will take time for the operators to execute and realise the restructuring synergies. We believe that the restructuring is positive for certain operators in the long term and valuations of current operators are attractive but would expect sector to underperform in the next 12 months.
What are the main challenges that you expect to face in the coming 12 months?
The global financials sector has been struggling to contain the ever-increasing sub-prime led problem leading to waves of massive re-capitalisation actions, bankruptcies and mergers. These transformations are still ongoing. Unprecedented global coordinated responses from financial institutions, regulators and central banks have finally shown some initial success in stabilising the sharp deterioration in global financial system and eased accentuated interbank rates.
With increasing participation by governments in recapitalising financial institutions, confidence in interbank lending has progressively returned. The extent or magnitude of a global economic recession emerging from the financial and credit losses and the spread of credit crunch is still in question.
We still have to monitor whether there will be any large scale financial institution bankruptcies resulting from this severe financial and real economic crisis. Whether or not financial authorities are able to manage and contain a crisis of this magnitude still needs to be challenged over the next few quarters.
What are the main risks of investing in Hong Kong and China?
The real economy has begun to experience the full force of the impact from current global financial crisis. Proactive responses from central banks and government will continue to be needed to minimise these negative impacts. Downward revisions in key macroeconomic drivers for 2009 such as industrial production, inflation, interest rates, private consumption and employment are already partially reflecting such changing outlook.
Unavoidably, 2009 economic growth for both China and Hong Kong is also being revised down. China may even temporarily ease below the much needed 8% p.a. growth on a quarterly basis. To mirror this macro economic outlook, earnings expectations are also being revised downwards. We remain vigilant to these impacts on companies in Hong Kong and China. While equity markets will remain volatile further heightened by sporadic fund flows, quality large-scale companies with resilient balance sheets, cash flows and well-observed corporate governance should be consistent outperformers under current uncertainties. We maintain our bottom-up stock selection strategy taking into consideration both valuations and near term catalysts.
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