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By Michael Lai, fund manager GAM Star China Equity GAM Star Asian Equity and GAM Star Asia-Pacific Equity
The massive sell-off in late June and July in the Chinese market shares A-shares has meant that many listed companies in Hong Kong have gone under pressure because of forced sales. From our point of view, we have been able to take advantage of this collateral damage and we increased our positions in the fund’s portfolio GAM Star China Equity with attractive prices. And this certainly is good news, because a market that is already at a discount has become even more obvious, while the fundamentals of the companies in which we have invested have remained positive. We bought using the revenues recorded on our exposure to shares A-shares, positions that we have completely closed after seeing the effects of recent government interventions in the market. Our portfolio remains highly liquid, and we have no way between those currently suspended from trading.
The concern of investors about the extent of government intervention on the stock list A-shares. For us, this issue is less relevant given that today we invest in much more transparent market in Hong Kong, although we are aware that there will be further consequences. We continue to focus on fundamentals and valuations, factors that always prevail in the long run. The current season of quarterly should allow us to understand if investors are once again beginning to differentiate between the best companies and useful, and those of lesser quality. We invest in companies that have some ability to pricing, in the service sector for example, which have high entry barriers and which are able to generate strong cash flows which are then redistributed to shareholders. Even in the range of our favorite sectors, technology and advanced manufacturing, we must invest indiscriminately, because the key is diversification.
For example, Baidu, the most popular Chinese search engine comparable to Google, It reported fairly weak numbers last week and has also published a forward guidance quite conservative. The company is trying to reach Alibaba and Tencent in some sectors, such as services online-to-offline (O20) that directs users online in physical stores. State intervention in China are hardly a novelty and have always involved a challenge to the A-shares market. The upside is that most of the inefficiencies that had accumulated on the market now has failed. We are seeing a significant process of deleveraging among investors, with the margin on the outstanding debt down 40%, from 2.4 trillion to 1.4 trillion renminbi. The last figure is more or less at the previous level soaring last March / April.
After the correction, the stock market of China H-shares currently has a price / earnings ratio around 8 , 7x, while the same indicator for the fund’s portfolio GAM Star China Equity is around 11x (13x was in late June). Looking at the values of the past, we believe that current valuations are at the lower end of the range of exchange both for the fund and for the market.
In summary, we see more encouraging news from China in the first half of 2015, which compared to any other time in it dominated by slashing the price list A-shares. Moreover, China is usual to take two steps forward and one back, and, in this case, the intervention on the stock market A-shares represented a step backwards especially long. And ‘interesting to note that the widening of the fluctuation band of the renminbi last week was interpreted as negative, while, in reality, is clearly a very positive decision. This means that the renminbi is moving towards full convertibility, but without this it means necessarily that the currency will depreciate. The main point is that this is a prerequisite for the IMF to accept the renminbi as a unit of exchange in the Special Drawing Rights (SDR).
The lesson to take home is that the government is fighting like never before the negative elements that weaken the economy. Of course, the extension of loans to excessive margin will always be a problem. And this, from our point of view, there appears to be a healthy correction required. In a context where the fundamentals are unchanged, the current level of valuations is an interesting entry point on companies with solid business models.
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