Value Partners keeps faith in B shares

Hong Kong-based Value Partners is launching a B-share fund to target undervalued shares. Associate director Jonathan Liang says market reforms will benefit the fund.

Q: What can you tell us about the fund?

A: It'll be open-ended. The chief reason we have launched this fund is because B shares are very much a forgotten market by foreign investors. We see a lot of value in the markets.

Q: What's the fund's estimated return in the first year?

A: I would love to answer your question, but because the fund is not approved yet I cannot give you too many details. It usually takes two to six months for a fund to be approved in Hong Kong. As to investing in China, we already have an investor ID there.

Q: How big does your fund have to be for it to be viable?

A: We have commitment from some institutions for $11 million as a start-up fund. Our target of asset under management is between $20 and $30 million.

Q: Why are B shares undervalued?

A: It's because foreign investor sentiment has been poor. But I think the chief reason is poor liquidity.

Q: Is the quality of stocks also a concern?

A: I think it is. There are 108 B shares in the markets. We think less than 20 are worth investing. And we'll probably be investing in less than that.

Q: What kind of stocks are you targeting?

A: They are not in any one particular sector. For example, we think TV manufacturer Konka is a strong company with good earnings. We also view Shenzhen Chiwan Wharf favourably; they operate container ports. Guangdong Electric Power is also pretty good. These companies have also issued A shares. They've got the same voting rights, same dividends. However, on average A shares are trading at a P/E [price to earnings] ratio of almost 50 times, whereas B shares are at about 12. That illustrates my statement about undervaluation.

Q: How are you going to position your fund?

A: We have accumulated some positions some months ago in the B shares with our existing funds. We would like to go in while they are still trading at a P/E of 12. Because we can see that the government has actually taken some concrete measures to reform the capital market. Some of the measures were targeted at B shares. For example, they've cut the stamp duty on B shares from 0.4% to 0.3%.

Q: What's the significance of that cut?

A: The cut in stamp duty is not that significant. However, it's the market sentiment that reform measures such as these can bring about that translates into profits. For example, in March 1999, B shares were at their all-time low. Then the government announced measures after measures to reform the capital market. And B shares have been gradually rallying since.

Q: Isn't it the case that B shares are riding high because of rumours that A and B shares are going to merge?

A: Not entirely. Ultimately, yes, it's what every B-share investor hopes for. However, as China opens up its capital market to foreign investors you'll find that liquidity will gradually improve as the health of the market as a whole improves. For example, there's also talks about introducing Sino-foreign joint venture mutual funds to B shares to give mainland Chinese indirect access to that market. We think that will substantially boost the liquidity for that market.

Q: How would joint venture mutual funds improve liquidity and market depth?

A: I don't know how the market depth will increase. It will depend on the size of the funds that the government allows joint ventures to put in. And if B shares were to reach the price levels of A shares, we're looking at a potential increase between 100% and 300% for B shares. As for local investors holding B shares, they obviously have been able to exploit some loopholes. But if you legalize it, everyone can do it.

Q: How difficult is it to gather reliable company information?

A: There's very little research done on the market because the turnover and the market capitalization of the stocks there are so small that brokers cannot really earn a sizeable income by doing research there. We have devoted more than three years of our time to researching B shares; carrying out on average more than 100 company visits to China each year.

Q: It seems the success of the fund will be hinge on a merger between A and B shares.

A: No, we don't see that. Because there's such gross undervaluation in that market, a correction of the value of those stocks will allow us to do quite well. But, in the longer term, we believe it's inevitable that B shares will merge with A shares. The current A-B structure is very typical of a regional emerging market. India and Taiwan formerly had this A-B structure. When they realized that it was not viable, they adopted a so-called QFII [qualified foreign institutional investor] structure. And we foresee that China will adopt this structure too, eventually.

Q: But that QFII system is supposed to facilitate investment in the A-share markets, not B shares.

A: Yes. But if that structure is adopted then it's likely that A and B shares would be merged.

Q: How do you think this process will be carried out? For A and B shares to merge the renminbi will have to be made fully convertible and it seems the government is not planning to do that.

A: Not yet. But as you can see, China is moving towards embracing the world community. In order to seriously attract foreign direct investment, they must make the currency convertible.

Q: That is a very big change to make to accommodate the B-share market.

A: Exactly. That's why we do not see the merger happening anytime soon. In fact Anthony Neoh [chief adviser to the China Securities and Regulatory Committee] mentioned that it would take two to three years.

Q: Realistically, it would take two to three years just to introduce capital control measures, and it would take them much longer than that to make the yuan fully convertible.

A: That's true.

Q: There are rumours that companies with both A and B shares are likely to buy back some B shares. How will that impact on the B-share market?

A: It's too hard to call.