A Fundamental Look At China’s ‘A’ Share Market

Singapore's APS sees plenty of opportunity ahead

Originally published in the June 2008 issue

China never seems to stay out of the headlines these days. And its high media profile is also focusing attention on the investment prospect it represents for global hedge fund investors. Ignorance and fear has never been more appropriate when used to describe foreign attitudes to China and, while there remains enthusiasm within the global investor community for the opportunity that Chinese growth represents, there is also concern about what would happen to global markets if the China story is derailed.

Wong Kok Hoi, the Chief Investment Officer at Singapore-based fund manager APS Asset Management, approaches the China conundrum with particular calm and sanguinity. His firm launched its China A-Share Fund in 2004 to capitalise on what it sees as the long-term investment prospects of some of the companies listed in the A-share segment of the Shanghai and Shenzhen stock exchanges.

A-shares are issued by mainland Chinese companies and are quoted in renminbi. They are generally available only to local investors and a few select foreign institutions. Wong has used this market to achieve some outstanding results for his fund (up over 640% since inception). But will the China gravy train continue to run on time?

China’s inflationary spectre

Inflation has to be one of the bigger challenges facing China’s economy at the moment, but Wong is not over-reacting to these fears. April inflation figures hit a decade high at 8.5%. “It will always be on the high side for an emerging double-digit growth economy,” Wong says. Your nerves calm a little when the numbers show that some 80% of that has been driven by food prices.”

China is facing higher meat and rice prices alongside higher energy prices as it continues to strive to modernise its economy. Wong reckons the authorities could reduce food prices by allowing more imports, but they want farmers to benefit from the increased wealth such prices hold out. After all, for some time now the large agricultural component of Chinese society has been lagging the new urban middle class in the wealth stakes.

Wong predicts that in the second half of this year inflation will come down to below 8% as the supply of pork increases in the second half of the year. “The government will not allow it to threaten economic growth,” he says. A lack of large scale food protests, as seen in other parts of the developing world, is being viewed as evidence that the livelihood of the people has not been affected very much, unlike the 1995-6 inflationary cycle. Wong accepts that 5-6% inflation is inevitable for an economy that has been growing at 10% a year and would like to see inflation drop to that level by next year.

As for other macro factors, would a US slowdown this year have a negative impact on Chinese exporters? China is not as dependent on foreign exports as some investors might think: Net exports accounted for about 25% of the GNP growth in the last three years whilst the rest is accounted for by capital investment and consumption. Indeed, with an overheating domestic economy, a slight slowdown in exports is not necessarily a bad thing. “If I were a policy maker in China, I would see a US recession as a god-sent gift,” Wong says.

A loss in export sales would hit low value-added manufacturing, but the domestic economy is still powering ahead. For example, the consumer is still buying and the Chinese financial services sector is booming, unlike in other parts of the world. The perception of international investors is that loss of exports equals very negative news for China, but in Wong’s view they are getting things out of proportion. They are choosing not to look at the domestic story and the respectable earnings growth some Chinese companies are still showing. Banks reported 80% earnings growth in Q1 and overall corporate earnings are still predicted to grow 20-30% this year. “Why should I lose sleep when the Chinese economy would still grow a respectable 8-9% in a global economic slowdown, even if it were to cascade down to domestic consumption and capital investment?,” Wong asks. “Where else can we find such robust growth?” He thinks that investing in currently overheated economies in a softening global economic environment seems to make most investment sense.

The recent market correction is more a reaction to fears of the unwinding of the strategic stakes by governmental entities than to a slowdown of earnings growth. When the government assured investors that it would not do so the market rebounded 20% in a week. Wong believes that the recent market correction provided investors with a great opportunity to get exposure to China’s long-term growth story at 18X PER, provided of course QFII quota is still available.

A short history of capitalism

Wong is not a political analyst and won’t try to second guess China’s State Council. He focuses on company fundamentals when making his assessment of where to invest. He can’t short the A-share market, so has limited scope to exploit share prices which go south. Nor does he buy into firms which have strong political interests in their shareholder registries. As a seasoned emerging markets investor he feels such firms can be held hostage to the idiosyncrasies of their owners. But there is still plenty of quality out there, he argues. He sees this fund as a long-term investor, despite the 70% turnover in 2007 which he says is unusual for his firm’s investment style.

Says Wong: “The history of capitalism in China is short. The pool of experienced analysts and fund managers is still small, and there is ample evidence that the market is inefficient. China is still an emerging market, and it will take time for it to institutionalise and liberalise its securities markets but it stands to benefit tremendously if this liberalisation moves fast.” APS is certainly serious about keeping track of its portfolio in China, the first foreign asset management firm with three research offices on the ground (Shanghai, Beijing, and Guangdong). Considering the size of the firm, it is indeed serious in investing and building a strong presence in China.

“We believe that to do well in China, you have to do your research on the ground,” Wong argues. “Different people may have different views, and as fund managers we have always felt that we need to get to know intimately the managers and owners of the investee companies we invest in. We need to know their integrity, their competence and their track records.”

And what of corporate governance, often the bane of Asia fund managers? “You hope that will improve with every passing year, and there are good signs,” says Wong optimistically. “Needless to say, we are sometimes fearful that fraud might happen amongst our investee companies.” APS ensures, as part of its risk management protocols that it never owns more than 10% of a company’s stock in the portfolio- the average position is usually 3-4%.

This emphasis on transparency is apparent in APS’ approach to stock-picking as well: “We prefer companies in industries with higher trade barriers and where we understand how they make their money,” says Wong. “We stay away from things we don’t understand. And for things we understand and like we try not to overpay.”

Ultimately, APS’ approach is not rocket science: its CIO understands China’s markets have a life of their own (the country has millions of day traders already, and some companies’ shares experience 100% turnover in a day) and that there is no point trying to forecast them. “Some investors feel fundamental research does not pay in this market, that rumours and inside information are better, but our performance bears out the fact that it can work,” says Wong.


Chief Investment Officer, APS Asset Management

One of the most successful fund managers in the China market space to date, Wong launched the APS China A-share Fund in 2004. He has over 25 years of experience in the investment industry, including with Citibank, Japan and GIC in Singapore. His A-share fund has outperformed for 4 straight years and is up over 640% since inception with an annualised return in excess of 70%, this against an index annualised return of approximately 34%. It has continued to outperform in the recent market correction.