China should rein in liquidity, says Foundation's Liang
Michael Liang is chief investment officer of Hong Kong based hedge fund Foundation Asset Management. He helped establish the firm in Hong Kong in 2006 with Singapore's UOB and Britain's CIM Investment Management. The Foundation China Opportunities Fund launched in early 2007 and is the manager's only offering. Liang has also worked for UOB Kay Hian, DBS Vickers, Daiwa SMBC and SG Securities. We spoke to him to get his reaction to events in China.
How did your fund perform in 2009?
We were up almost 38% last year, which was below the increase in the index. However for the 2008-2009 two-year period, we were up 16% and the MSCI China was down 25%. The size of the fund is $15 million, but adding on managed accounts and other mandates we manage about $80 million.
How did you get that 38%, alpha or beta?
We're quite conservative and had gone into 2009 with a small exposure. The market tends to work on a second derivative of economic growth -- that is, the rate of change of increased growth. In 2007, we saw the peak of economic growth [in China], and since then [the Chinese economy] has still been growing, but at a slower rate, and that hit its lowest point at the beginning of 2009.
What is your strategy for 2010?
We weren't expecting the market to come back so quickly, with a vengeance. You could say now that the liquidity that was pushed out by the banking system was overdone. The new lending handed out in 2009 was probably 30% too high. This excess liquidity needs to be taken back in 2010. How will that take place? That's tricky to say, but we think tighter control over lending should be done as soon as possible for the sake of growth in future years.
It's a planned economy with capitalist mechanisms. That is not fully in place yet. They are trying to keep a straight line of growth; that works for a short period of time, but the market doesn't allow that for a long period and has its own way of adjusting itself.
If interest rates are raised too aggressively, that might bring in hot money flows. So there may be some quota for new loans, perhaps a quota that is not explicitly spelled out, and a call for daily details of new loans to be reported by banks and for a halt to new lending at some threshold.
Rumours are saying that new loans for the first three weeks of January were Rmb1.5 trillion [$219.7 billion]. Now the soft target for new lending is Rmb7.5 trillion this year. So, however that breaks down, with perhaps more lending in the first half than in the second, it still cannot be Rmb2 trillion per month.
I think reforms that happen this year will be important in carrying forward growth. The daunting task is to tackle rising inflation and runaway property prices. The other reforms -- healthcare, financial market, retirement -- stay on the agenda, but one has to have reservations about the relative priority that they will have.
What sectors do you think will outperform and underperform in China?
The private sector has been crowded out in China, and fixed-asset investment has gone through the roof. I think the latter fixed-asset sector will underperform this year and offers potential for shorting, along with the likes of, say, infrastructure, steel and aluminium.
I think the real economy will do well due to the momentum, and that may well result in double-digit growth initially, but decline later.
For banks, non-performing loans are unlikely to emerge for a couple more years, so that won't be a major topic for this year. When people are nervous, though, bansk can be an easy large-cap target. Profit in banks should continue to do well, with increased pricing power in a rising interest rate environment.