Premium looks for China at a discount

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Buying momentum in the Chinese share market is a “very dangerous” tactic, according to Jonathan Wu, Premium China Funds executive director.

The Sydney-based Wu said, on a visit to New Zealand clients last week, that simply following on-trend stocks in China – or taking a broad passive exposure – exposes investors to the risk of rapid reversals in a market prone to fluctuating sector fortunes. He said China shares rewarded stock-specific investors, particularly those with a value bent.

Bloomberg data shows over the 20 years to 2017 the MSCI China Value Index outperformed both the broader and growth Chinese market benchmarks by factors of about three and seven, respectively.

During the 20-year period China value shares returned a total 216 per cent compared to 31 per cent for the growth index and almost 84 per cent for the broad MSCI China benchmark.

But investors also have to remain aware of rapidly-changing income and spending dynamics in China, Wu said, with different sectors set to benefit.

He said research shows the proportion of high-income earners in China (classified as annual income of more than RMB200,000 – or about A$38,000) should almost quadruple to about 11 per cent of the population by 2025, bringing 39 million people into the upper bracket. At the same time, China would see a broad jump in income levels as the percentage of low-income earners falls from the current 37 per cent of the population to 20 per cent by 2025.

Wu said the income trends bode well for Chinese internet, gaming and consumer discretionary stocks.

He said the Premium China Fund – managed by Hong Kong-based Value Partners – recently rotated out of higher exposures to real estate and healthcare in favour of IT and consumer discretionary companies.

The Premium fund now has an almost 30 per cent weighting to the IT sector and 18 per cent in consumer stocks.

But even within the favoured sectors investors need to be selective, Wu said. For example, the fund’s two largest holdings – Alibaba (the TradeMe of China) and internet and online payments firm, Tencent – both have robust “capitalist” business models, he said, based on true commercial advantages.

However, the Premium fund eschews another internet darling, Baidu (the Google of China), due to its government-protected mandate.

“The government could change its mind and allow Google into China which would seriously threaten Baidu,” Wu said.

He said the fund is also careful about how it gains exposure to the Chinese stocks with most investments made via the Hong Kong-domiciled China H Shares market rather than mainland China A Shares.

Currently, H Shares were trading at a discount to China A Shares, Wu said.

The inclusion of China A Shares in the MSCI global indices announced last month – and due to take effect next year – would eventually change trading dynamics in the mainland bourses, he said.

In addition to its equity exposures via the China and Asia funds, Premium is also pitching an Asian fixed income fund as an alternative yield product.

Wu said the Premium Asia Income Fund (managed by Value Partners), which focuses on the senior unsecured debt market across the continent, offers a novel approach in a global fixed interest market typically weighted towards low-risk, low-yield rated securities or higher-yield junk bonds and hybrid products.

He said the fund, averaging 6 per cent annual distribution since inception, plays in the lowly-rated to unrated Asian corporate bond market. According to the latest data, about 40 per cent of the fund is in B-rated or below bonds with 36 per cent unrated: the remainder is split between cash (6 per cent), BB-rated (10 per cent) and BBB-rated (3 per cent) securities.

Just over half of the fixed income exposure comes via Hong Kong and China with real estate (36 per cent) the dominant sector.

Research house Lonsec says the Premium Asia Income fund is managed to a “value-oriented” approach supported by bottom-up research”.

“This results in a portfolio of fixed interest securities issued by companies, which, in the view of the Manager, are undervalued, on either an absolute or a relative basis and have the potential to generate regular income and some capital appreciation,” Lonsec says. “This includes securities that the market views as severely distressed, meaning debt issued by companies that are at risk of going into bankruptcy, have already entered bankruptcy or are considered to be under severe financial stress.”

  • David Chaplin, Investment News NZ
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