China A-shares may go from worst to first in 2009

Marco PoloÆs Alan Landau expects 2009 to be a return to happier times for A-share investors.

Marco Polo's Pure China fund ended 2008 as the best performing QFII fund, based on information available on 17 passive and actively managed funds tracked by Lipper, Eurekahedge and Bloomberg.

Last year, of course, 'best performing' did not equate to 'making money'. Even the Marco Polo fund ended the year down -46.49%. But while all QFII funds are in the red, the road to returning to the black will be much longer for those who lost as much as 65%. The silver medal goes to PCA Dragon Fund, down -48.49%, and the bronze to Morgan Stanley A-Share Fund, down -51.12%.

AsianInvestor spoke to the president of Marco Polo Investments, Alan Landau.

How did you perform in 2008?

The average QFII fund was down approximately 57.8%, and our flagship outperformed by approximately 11 percentage points. Looking back over both 2008, when the A-share market was one of the worst performing markets in the world, and 2007, when the A-share market was one of the best performing markets in the world, our flagship fund was again the best performing QFII fund and one of only five that had positive returns during this period. We are extremely proud that we have outperformed both the market and our peers in both bull and bear markets.

Is there any good news ahead?

The best news to report though is that 2008 is over. We are in a new year, 2009, and while challenges remain there are also opportunities. We are moving to our highest net-long exposure since the beginning of 2007.

What is your outlook for China's A-share markets?

Our general view is that the market continues to be oversold and presents good long-term value at these levels. Despite the recent rise in share prices, the average market price earnings ratio is still far below its long-term historical average. A simple reversion to this valuation mean would imply substantial upside potential for the market. Nonetheless, we focus on economic and company fundamentals.

How do you view China's economy?

From a fundamental top-down perspective, we see a Chinese economy that is slowing, but appears to have averted a collapse. Gross domestic product is driven by three major engines: exports, fixed asset investment and domestic consumption.  While exports have slowed dramatically, FAI (fixed asset investment) and domestic consumption are showing resiliency. FAI growth is still at very high levels and was actually higher in 2008 than in 2007. Most importantly, it is supported and should continue to be supported by government spending, especially the Rmb4 trillion spending package.  

What is the strength of domestic consumption in China?

Domestic consumption is the biggest component of GDP growth and remains very strong. Retail sales, a good proxy for consumption, were up sharply in 2008 versus 2007, and despite a slight slowdown in growth, December retail sales still grew by 19% year on year, which was not far off the 23.3% growth rate in July, which was a decade high.

We think that the Chinese economy will avoid a collapse in 2009 and see GDP growth of between 7% and 8% because exports will begin to recover in the second half of the year, domestic consumption will remain strong on the back of a resilient consumer class, and FAI will be boosted further by the central government.  

In our view, China is in the best position of any country because it avoided the credit and confidence collapse in the West; has a strong balance sheet with low levels of government and consumer debt; has ample government resources to stimulate fiscally; and has a lot of room to loosen monetarily.

What sectors are you focusing on?

From a bottom-up perspective, we are focusing on sectors and companies with stable growth prospects, solid demand and foreseeable earnings. We think that sectors that are the focus of positive government policies are key, especially those that will benefit from government spending and reform. We are weighted towards such sectors/sub-sectors as healthcare and pharmaceuticals, retail, food and beverage, equipment manufacturers, construction, media and financials.

While we think that there will continue to be volatility in the first half of the year, afterwards, as investors start focusing on a recovering economy, we believe that the market will return to the longer-term bull market cycle. We think the recent bear cycle was only a hiatus in that cycle.  

This year should offer moderately positive returns, although we think there is the potential for big gains, depending on how the rest of the world does and on how some other A-share market specific issues develop, such as the pace of sales of unlocked non-tradable shares into the market. We think that A-share market will likely be among the top-performing equity markets in the world in 2009.

Are investors apprehensive about China?

Surprisingly, we saw net subscriptions in 2008. In a year when many funds saw substantial net redemptions and some were forced to put up gates or close, our investors actually gave us more capital. That is a huge statement of their confidence in us. As we look forward into 2009, we want to substantially increase subscriptions. This could be the year.

Going in to the last bull market, when many investors had never heard of the A-share market, it was difficult to raise large sums from institutional investors. However, now, the A-share market is known worldwide and is considered a serious international market. Many major international investors, including Goldman Sachs, UBS and Deutsche Bank are already QFIIs and many more are seeking QFII status. Yet, funds like ours remain one of the few methods for non-QFIIs to gain access to the A-share market.

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