Reports of China's economy slowing should be looked at from two perspectives: the macroeconomic and the microeconomic, says Kai-Kong Chay, manager of the $45.5-million Manulife China Class.
"On the macro level, you can see from recent numbers of industrial production and fixed-asset investments that the economy is recovering and going through a so-called soft landing," says Chay, Hong Kong-based managing director at Manulife Asset Management and senior portfolio manager for Greater China equities. "But on the corporate-earnings front, it's more like a hard landing."
The Producer Price Index, or PPI, has gone from 7% at the end of August 2011 to minus 3% in October 2012. "At the start of 2012, we expected 15% earnings growth. But this year, it's down to zero -- it's pretty severe," says Chay. "That's why the market had a correction last summer."
With the Chinese economy rebounding again, earnings should recover. "We're not expecting a sharp recovery, and think it will be muted," says Chay. "GDP growth in 2013 should be around 7% to 8%."
China is shifting from an export-based economy to one focused on domestic consumption. "They are also trying to boost wages, by increasing the minimum wage. As a result, they will move low-end manufacturing to the poor western regions," says Chay.
The more prosperous coastal regions, Chay adds, will focus on higher-value-added exports. "It will take a while. That's why you won't see 10% GDP growth for two to three years. Unless, of course, the economy is transformed so that consumption achieves a critical mass. Then you'll see a re-acceleration of growth."
A growth-at-a-reasonable-price, bottom-up investor, Chay assumed the portfolio in April 2011 and reduced the holdings from about 100 to between 60 and 70. Single positions are limited to about 6%. Turnover in the year ended April 30, 2012, was fairly high at 165%.
"We look for catalysts and identify changes in a company or sector," says Chay. "If something is changing, and will bring an increase in earnings, but it's under-appreciated by the market, then we'll buy a lot of these stocks." As the fund tends not to follow the benchmark MSCI Gold Dragon (C$) Index, it is moderately over-weighted in Hong Kong, which accounts for about 25% of the index, and slightly under-weighted in Taiwan, which represents about 28% of the index.
One representative holding is Mediatek Inc., a Taiwan-based handset chip maker that is benefitting from demand for low-cost smartphones. "People were skeptical about them because they were competing against giants like Qualcomm Inc. But they launched their smartphone products and have shortened the technology gap," says Chay. "Now, they are on a par with Qualcomm, in terms of technology."
While the stock has had a good run, Chay believes there is more upside. "Earnings should be about 20% higher than the consensus estimates."
A native of Singapore, Chay has been in the industry since 1995 when he graduated with a bachelor of accountancy from Singapore's Nanyang Technological University. He joined Price Waterhouse as an auditor but developed an interest in fund management while completing his CFA.
"In auditing, you talk to a lot of different companies and learn how they manage their operations," says Chay. "I thought this skill set was very useful and I could use it in fund management, in terms of analyzing companies."
After two years as an investment analyst at Singapore-based United Overseas Bank Asset Management, Chay joined CMG First State as an assistant portfolio manager on the Greater China Fund and Hong Kong China Fund. He stayed for two years and then moved to Pioneer Investments, where he was a senior analyst and covered the technology, materials and industrial sectors in Asia.
Six years later, Chay was recruited by Standard Life in Hong Kong, where he was a senior portfolio manager working on its Greater China fund and the Asian portion of the emerging-markets fund. After three years, Chay moved to Reliance Asset Management in Singapore, where he helped the firm launch new products. In December 2009, Chay joined Manulife in Hong Kong.
The 3-star rated Manulife China Class returned 18.9% for the 12 months ended Dec. 31, compared with 16.2% for the median fund in the Greater China Equity category. Over two years, it had an annualized 3.9% loss, versus a 4.3% loss for the median fund.
Looking ahead, Chay expects that as China's GDP rebounds, earnings will recover, too. "Right now, it's uneven. But we are seeing better signs in Chinese property companies. Power-generation companies are seeing lower coal costs, which is benefiting their margins quite favourably. And we continue to like consumer stocks."
