David Hepworth, co-portfolio manager of Idaho-based Interfund Capital's China hedge fund, talks about exploiting opportunities in the China market.
What type of investment strategy does the Interfund Capital China Fund employ?
Hepworth: We're an opportunistic, long-biased fund. We do employ some use of leverage and do short stocks on occasion. Our use of shorting is not so much for arbitrage purposes but rather to take advantage of opportunities when companies become overvalued.
What types of stocks do you invest in?
We invest in companies we feel are benefiting from the rapid growth of the China market. Most of our investments are in stocks listed in Hong Kong, Taiwan and Singapore and companies heavily oriented towards China. We also invest directly in Chinese companies listed in Hong Kong, or on the NYSE and Nasdaq. We hold most of the stocks in the Halter USX China Index [an index devoted to China focused public companies trading on the US stock exchange]. These include Chalco, PetroChina, Sina and Sohu, for example.
Do you invest in the China A-share market through an institution with a QFII licence?
We're not QFII qualified, but are interested in getting exposure to the A-share market through a qualified institution. At the moment we're in discussions with Deutsche, UBS and Lehman, although Lehman do not currently have a license.
We see these restrictions on foreign investments dropping off significantly in the next four years. At least by the 2008 Olympics we expect the stock market to be fully open, creating a level playing field. We aim to position ourselves to take full advantage of this opportunity as it arises.
Which sectors do you like at the moment?
I think telecoms are very exciting right now, as are companies that manufacture for telecoms. We are also investing in downstream petrochemical plays and power companies. We are somewhat concerned about commodities plays.
Outside of China, we are particularly keen on Volkswagen as a China play.
What current long/short positions are you holding?
Most recently we were long PetroChina and short Netease. Our decision to short Netease was an example of how we benefit from information arbitrage. On a recent trip to China we realised the government was cracking down on SMS adult entertainment, which would affect Netease in particular. This is something people in the US didn't know about as it hadn't been reported in the any newspapers.
What do you think of recent China IPOs, such as China Life?
I like China Life, despite the run up. I am also looking forward to Ping An. I think life insurance is a great fit with the savings habit of the Chinese. China is a huge market and these firms are going to have monopoly access for a long time to come. Foreign firms are going to find it very difficult to compete with this.
How about the upcoming banking sector IPOs?
I don't expect these to come to the market for another 16 to 18 months. But, to the extent that the capital injections and listing plans for the banks presage an attempt by the government to transform their system from within rather than adjusting the value of the renminbi, this would be an extraordinary development.
The high savings rate in China does make the banking sector attractive, but the real issue will be whether strong enough management can be brought in to reform the banks. I am a bit concerned about the property companies at the moment. They have just kept on building and are soon going to face deflationary pressures. Of course, their losses are not going to show on their books but will be suffered by the banks.
Are there any challenges to operating a China-based fund out of Idaho? How do you keep in touch with developments in China?
With the internet these days it doesn't really matter where you are located. Idaho is a beautiful place, and I enjoy living there. However we are looking to expand and are considering opening offices in San Francisco and Shanghai.
My co-portfolio manager and I go to China about two to three times a year. We also have two Mandarin-speaking analysts working with us who make frequent trips to China, and two China-based consultants. We also read the Chinese press and have found the research reports of Guotai Junan Securities particularly insightful.
What attracts you to China?
We are an opportunistic fund, and China is certainly a market with a great deal of opportunities, with the potential to be explosive on both sides. We position ourselves to benefit from the market going up as well as down.
Shorting stocks involves a lot of detective work and we've also found that in China information arbitrage still exists. For example, information about corporate activities that appear in the Chinese press still take two or three months before they reach US newspapers.
Personally, I have always been fascinated by China. Things have changed so much since I was young and we were told that we would never be able to go to China.
How large is your fund at the moment and who are your investors?
At the moment, our fund is just under $50 million in size. We launched it in November last year and expect it to close within the next six months. Our investors are US-based high net-worth individuals, institutions and pension funds. At the moment only US investors are qualified to participate in our fund, but we are considering launching an offshore fund with a similar strategy to cater to international investors.
What types of returns are you targeting?
We are targeting an annual return of about 300-400 basis points above the MSCI index. However, since we launched our fund in November we have far outperformed our targets thanks to the unbelievable performance of the Chinese market in December.
Do you think there are enough funds to satisfy the growing investor appetite for investments in China and Asia?
No. I think capacity in quality funds is certainly going to become an issue.
What were you doing before you set up Interfund Capital?
I graduated from Amherst in 1980, and since then I've worked on portfolio analysis and sales for a number of institutions including Merrill Lynch, Prudential, Lehman and most recently, Alex Brown. I co-founded Interfund Capital in 1992. We act as general partner to several funds in the market and manage investments for high-net worth individuals. We launched our China Fund in November last year.