Schroders sticks with defensive China plays
The fund house is still cautious on China, but expects its risk appetite for that market to grow in the next two quarters.
Since stock markets typically trade ahead of the real economy by about six to nine months, Schroder Investment ManagementÆs portfolio manager for China and Hong Kong, Laura Luo, believes that those markets will start to see signs of growth in the third or fourth quarter of 2009.
Schroders has maintained a defensive position in its portfolios throughout 2008 but has slowly increased the risk as markets have pulled back. For example, the fund house has started to rotate out of more defensive Taiwanese names into the better quality Chinese companies in its Greater China and regional portfolios.
At this point, Schroders is still taking a cautious approach but expects its risk appetite for equities in the region to increase in the next two quarters.
ôWe are actually relatively optimistic. We were huge bears throughout 2007 and today, from a bottom-up valuation perspective, are finding lots of interesting opportunities in companies that have strong cash flows and quality management,ö says Luo. ôWe have also reduced our cash position in our portfolios, though we do not typically run our portfolios with a lot of cash rather remaining near fully invested.ö
Luo is the lead portfolio manager of the $598 million Schroder ISF China Opportunities fund. As of end-October, the fundÆs top five holdings were China Mobile, Cnooc, Industrial & Commercial Bank of China, China Construction Bank, and China Communications Construction. In terms of sectors, financial services make up around 25% of the portfolio. Others in the top five in terms of sector allocation are energy, telecommunications, industrial materials, and business services.
China equities were sold down heavily as global recession fears intensified, exacerbated by worse-than-expected third-quarter earnings and fund redemption worries, Schroders notes. The marked slowdown in ChinaÆs third-quarter GDP data added to the uncertainty. However, hopes that the government would implement further measures to boost the economy helped stem the rout, with China stocks staging a dramatic rebound towards the end of the month.
Against that backdrop, the fund registered sharp losses in October, in line with its benchmark index. After gaining 79.2% in 2007, the fund was down 56.8% in the first 10 months of 2008, compared with a decline of 57.4% for the MSCI China Index in the same period.
Key purchases in the month included adding to China South Locomotive & Rolling Stock, which Schroders expects to be a major beneficiary of the central governmentÆs plans to increase railway investment to support the economy. Schroders also increased its exposure to China Mobile due to its earnings defensiveness and compelling valuations in the current economic downturn. On the other hand, the fund house reduced its exposure to Guangzhou Friendship Store as discretionary spending is likely to be affected by the economic slowdown and the negative wealth effect.
Luo has been in the financial industry for more than 12 years. She joined Schroders in 2001 as a research analyst, responsible for China market strategy and company research. She moved to a fund management role in January 2005, where she became responsible for China and Hong Kong mandates. Previously, she was head of China research at SG Securities, a research analyst at Morgan Stanley and Goldman Sachs, and a financial analyst at Bank of Nova Scotia. She shares her views about the prospects of Greater China stock markets.
What are the prospects for the Hong Kong, China and Taiwan stock markets in the coming months?
Luo: While it is true that 2009 will be a difficult year and it is likely that the media will continue to highlight negative earnings news over the coming months, resulting in choppy markets and even more volatile individual stock performance, we believe that much of this news is already in the price, but there will be individual surprises as we have already witnessed in the region. We expect to see a positive, or at least a flat trend, in the coming months within the continued volatility. And we will be looking to invest in those companies with strong balance sheets and credible management with a strong track record.
How severe of an impact will an impending global slowdown be on ChinaÆs export-driven economy?
We do not believe that domestic consumption can pick up the slack from the loss of exports. There is already evidence of slowing in discretionary spending and expectations for growth next year have already been revised downwards. We have been stating for some time that economic growth will fall to around 8% for 2009. In order to maintain this level, the government will change policy (as it has already started to do so) and use other measures to support consumption, the property market and the banking system.
We expect the government to invest heavily in infrastructure-related projects to help offset the slowdown from the lack of growth in exports or manufacturing. With growth at about 8%, while quite a bit lower than what we have witnessed in the most recent years, it should be sufficient to keep China's population employed.
China recently revealed its third-quarter GDP growth rate slowed to a lower than expected 9%. Do you believe we have seen the end of double-digit growth in China?
We expect growth for 2009 to be close to 8% and this is likely to be the case for 2010 as well. Double-digit growth is becoming harder to achieve, but is not out of the question. Back to back years of double-digit growth, however, it does look more of a challenge going forward.
China has become a major driver of growth for those economies that are commodity leveraged/dependant. As a growth engine for the US and Europe, the impact is not as significant where economies are driven more by domestic factors. As China moves up the value added chain and imports more sophisticated machinery, economies like Germany and Japan stand to benefit. Within Asia, China will continue to become a more important trading partner and driver of growth in the region. As the US is critical for growth in North America for its two main trading partners Canada and Mexico, China will dominate the Asia-Pacific region as it develops over the coming 20 years into a more consumption-led model and relies more on its neighbours.
What particular investment strategies do you foresee succeeding in the Greater China region in todayÆs market environment?
Long term, we still believe that being overweight China will result in success. However, for the time being, we are somewhat cautious given the global macro environment and remain in defensive names in the portfolio and in higher quality stocks in the region.
Regrettably, there have been few places to hide this year. Hong Kong utility stocks have performed well in the recent pull back but within Hong Kong, the outlook for these companies is not that strong and is not an area we will look to buy into. We have instead favoured telcos in Taiwan and China where we see better yields or greater growth. We have also had a preference for better quality technology names in Taiwan, which have strong cash flows and a strong record of dividend payouts. Within China as well, we have liked select infrastructure names and companies levered to domestic consumption. We have also started to see value in some insurance and energy stocks in China after the recent correction.
Is the concept of decoupling still relevant?
In the near term, unlikely, given globalisation and the trade and capital link. Still, decoupling for China is a long-term trend. As noted above, over the coming years China will become more dominated by consumption as it moves towards an economy more similar to that of the US. However, even in 10 years, China will be a long way from developing the same consumer dominated economy as in the US. However, that is most interesting from an investorÆs perspective as it provides great opportunities for stock pickers to identify those long-term winners.
Schroders has maintained a defensive position in its portfolios throughout 2008 but has slowly increased the risk as markets have pulled back. For example, the fund house has started to rotate out of more defensive Taiwanese names into the better quality Chinese companies in its Greater China and regional portfolios.
At this point, Schroders is still taking a cautious approach but expects its risk appetite for equities in the region to increase in the next two quarters.
ôWe are actually relatively optimistic. We were huge bears throughout 2007 and today, from a bottom-up valuation perspective, are finding lots of interesting opportunities in companies that have strong cash flows and quality management,ö says Luo. ôWe have also reduced our cash position in our portfolios, though we do not typically run our portfolios with a lot of cash rather remaining near fully invested.ö
Luo is the lead portfolio manager of the $598 million Schroder ISF China Opportunities fund. As of end-October, the fundÆs top five holdings were China Mobile, Cnooc, Industrial & Commercial Bank of China, China Construction Bank, and China Communications Construction. In terms of sectors, financial services make up around 25% of the portfolio. Others in the top five in terms of sector allocation are energy, telecommunications, industrial materials, and business services.
China equities were sold down heavily as global recession fears intensified, exacerbated by worse-than-expected third-quarter earnings and fund redemption worries, Schroders notes. The marked slowdown in ChinaÆs third-quarter GDP data added to the uncertainty. However, hopes that the government would implement further measures to boost the economy helped stem the rout, with China stocks staging a dramatic rebound towards the end of the month.
Against that backdrop, the fund registered sharp losses in October, in line with its benchmark index. After gaining 79.2% in 2007, the fund was down 56.8% in the first 10 months of 2008, compared with a decline of 57.4% for the MSCI China Index in the same period.
Key purchases in the month included adding to China South Locomotive & Rolling Stock, which Schroders expects to be a major beneficiary of the central governmentÆs plans to increase railway investment to support the economy. Schroders also increased its exposure to China Mobile due to its earnings defensiveness and compelling valuations in the current economic downturn. On the other hand, the fund house reduced its exposure to Guangzhou Friendship Store as discretionary spending is likely to be affected by the economic slowdown and the negative wealth effect.
Luo has been in the financial industry for more than 12 years. She joined Schroders in 2001 as a research analyst, responsible for China market strategy and company research. She moved to a fund management role in January 2005, where she became responsible for China and Hong Kong mandates. Previously, she was head of China research at SG Securities, a research analyst at Morgan Stanley and Goldman Sachs, and a financial analyst at Bank of Nova Scotia. She shares her views about the prospects of Greater China stock markets.
What are the prospects for the Hong Kong, China and Taiwan stock markets in the coming months?
Luo: While it is true that 2009 will be a difficult year and it is likely that the media will continue to highlight negative earnings news over the coming months, resulting in choppy markets and even more volatile individual stock performance, we believe that much of this news is already in the price, but there will be individual surprises as we have already witnessed in the region. We expect to see a positive, or at least a flat trend, in the coming months within the continued volatility. And we will be looking to invest in those companies with strong balance sheets and credible management with a strong track record.
How severe of an impact will an impending global slowdown be on ChinaÆs export-driven economy?
We do not believe that domestic consumption can pick up the slack from the loss of exports. There is already evidence of slowing in discretionary spending and expectations for growth next year have already been revised downwards. We have been stating for some time that economic growth will fall to around 8% for 2009. In order to maintain this level, the government will change policy (as it has already started to do so) and use other measures to support consumption, the property market and the banking system.
We expect the government to invest heavily in infrastructure-related projects to help offset the slowdown from the lack of growth in exports or manufacturing. With growth at about 8%, while quite a bit lower than what we have witnessed in the most recent years, it should be sufficient to keep China's population employed.
China recently revealed its third-quarter GDP growth rate slowed to a lower than expected 9%. Do you believe we have seen the end of double-digit growth in China?
We expect growth for 2009 to be close to 8% and this is likely to be the case for 2010 as well. Double-digit growth is becoming harder to achieve, but is not out of the question. Back to back years of double-digit growth, however, it does look more of a challenge going forward.
China has become a major driver of growth for those economies that are commodity leveraged/dependant. As a growth engine for the US and Europe, the impact is not as significant where economies are driven more by domestic factors. As China moves up the value added chain and imports more sophisticated machinery, economies like Germany and Japan stand to benefit. Within Asia, China will continue to become a more important trading partner and driver of growth in the region. As the US is critical for growth in North America for its two main trading partners Canada and Mexico, China will dominate the Asia-Pacific region as it develops over the coming 20 years into a more consumption-led model and relies more on its neighbours.
What particular investment strategies do you foresee succeeding in the Greater China region in todayÆs market environment?
Long term, we still believe that being overweight China will result in success. However, for the time being, we are somewhat cautious given the global macro environment and remain in defensive names in the portfolio and in higher quality stocks in the region.
Regrettably, there have been few places to hide this year. Hong Kong utility stocks have performed well in the recent pull back but within Hong Kong, the outlook for these companies is not that strong and is not an area we will look to buy into. We have instead favoured telcos in Taiwan and China where we see better yields or greater growth. We have also had a preference for better quality technology names in Taiwan, which have strong cash flows and a strong record of dividend payouts. Within China as well, we have liked select infrastructure names and companies levered to domestic consumption. We have also started to see value in some insurance and energy stocks in China after the recent correction.
Is the concept of decoupling still relevant?
In the near term, unlikely, given globalisation and the trade and capital link. Still, decoupling for China is a long-term trend. As noted above, over the coming years China will become more dominated by consumption as it moves towards an economy more similar to that of the US. However, even in 10 years, China will be a long way from developing the same consumer dominated economy as in the US. However, that is most interesting from an investorÆs perspective as it provides great opportunities for stock pickers to identify those long-term winners.
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