Pinpoint Investments

Relationships yield dividends in booming China

Originally published in the September 2008 issue

Times are changing in the world of Asian investing. In the last great Asian markets boom, in the mid-1990s, Greater China was one of a number of investment options asset allocators could consider in the region. Now, it has become the dominant strategic play. For the hedge fund investor interested in this theme, a small handful of China-specialist hedge funds have been carving a niche for themselves, combining local expertise with exceptional returns. Alex Li, the CEO of Hong Kong-based hedge fund outfit Pinpoint, one such boutique, sees the ongoing evolution of China as a major driving force behind the prosperity of the region’s other markets. At the same time, however, he feels Asian markets are the beneficiaries of the global liquidity model. Should we see a global recession next year, Asia will still suffer, as will China, he warns.

“We have not seen the decoupling effect that some people have speculated about,” he tells The Hedge Fund Journal. “The majority of the companies listed in Hong Kong may be China-focused, but Hong Kong is still correlated to the US.” Countries like Australia could still do well from the ‘China’ effect, because of the high levels of exports they ship to China, but at the end of the day, hopes that somehow China could still boom while the developed world enters a recession could be ill-founded.

Other investors have become concerned about the impact of rising commodities prices on China’s growth rate, but Li, whose firm manages the Pinpoint China fund, says China’s 7% annual inflation rate looks conservative compared with the double digit rates experienced by over 50 countries now. “Commodity price rises are a global problem,” he says. “China’s economy will be impacted, but we are still seeing healthy economic growth at the moment, amongst the fastest in the world. I don’t see it as a big problem.”

Pinpoint’s China fund was launched in 2005, and is run by portfolio manager Qiang Wang. It made a net return of 17.43% in 2005 on a YTD basis, then topped that in 2006 with 139.18%. In 2007 it returned almost 100%. It follows a bottom-up, fundamentally driven approach that relies on the investment team’s personal knowledge of China’s business sector.

China is changing

CEO Li says it is important to realise that China is changing from an export-oriented economy, to one where domestic markets have just as important a role to play. Exports currently account for approximately 40% of China’s GDP growth and, while companies with considerable exposure to overseas markets could suffer in a recession, Chinese income growth is also strong, accounting for 10% of GDP in 2008 and between 12-13% last year.

As a fundamentally-driven investor, Pinpoint pursues more long opportunities than short. Because shorting is banned in China itself, opportunities really tend to emerge on overseas exchanges, including Hong Kong and Singapore. “We would not want to risk shorting in slightly over-priced markets,” Li explains. “Stock lending fees are high and, while we might sometimes see opportunities, this is not like the US markets.”

China’s domestic securities’ story is one of more fundamental, medium to long-term investing, rather than active trading of liquid local blue chips, despite the activities of China’s emerging generation of day-traders. The market remains an inefficient one compared with other Asian economies and procuring enough information about a stock can sometimes be difficult. Similarly, it is much harder to predict China’s fiscal policy, again due to a lack of transparency in its decision making process.

Obviously, combating inflation and maintaining a high level of economic growth is a priority, but for Li second-guessing Beijing’s moves is notwhat his fund has been established for. “We take policy impact into consideration, but more from a perspective of its impact on our holdings: what will boost earnings, what will reduce liquidity?”

Li sees Pinpoint’s network of contacts in China as essential to its success. This includes maintaining harmonious relationships with company management and having an awareness of the unique cultural landscape of the Chinese business world. “I’m not saying other people can’t develop such a network, but even if both parties speak Chinese, there is still a need to understand the business culture. We can capture important information, both at the company and policy level. That kind of thing takes time to build, and I’m not sure everyone can do it,” he says.

One of the complaints levelled at China by some emerging markets fund managers is the lack of transparency at company level and poor corporate governance. This is less of a problem when things are going well, but during periods of market turbulence and when a share price is being punished, information can dry up overnight. During the infamous Thai baht crisis in 1997-98, many Asian portfolio managers were scarred by serious corporate governance failings on the part of some of the companies they invested in. Li points to a gradual trend towards improved governance in Greater China, driven by both investors and regulators. “It is becoming harder to commit fraud and overall we are seeing fewer scandals,” he says. “Accounting rules and disclosure requirements are at the same level as G7 countries.”

What of state or municipal-level involvement in some Chinese companies? Li accepts those firms with minority or majority state ownership can enjoy considerable advantages in China, but says typically the private sector will perform better. Assessing the level of state ownership is a significant part of Pinpoint’s due diligence process. “We look at the balance sheets and all other related information, and if we find anything we don’t trust, we don’t invest,” says Li.

Relationships are critical

Pinpoint enjoys a very relationship-driven culture, having grown out of a Shanghai-based wealth management business that managed assets for friends and family. Founded in 1999, it finally felt confident enough to launch its first offshore investment vehicle in 2005.

Its team is heavily focused on managing a long/ short portfolio in Greater China markets, including both the A-share and B-share market in Shanghai. It has gradually been expanding its expertise, hiring in analysts with a commodities background in order to capitalise on the strong commodities-driven theme behind the Chinese growth story. This has led to the launch of its Rising China Fund, which seeks to capitalise on the commodity-related opportunities yielded by the ongoing economic growth of both China and India, among other countries, across a range of asset classes.

Pinpoint maintains an internal team of generalist analysts, but shifts its sectoral focus depending on where it sees the greatest opportunities in China. For example, this year it is concentrating on both ends of the product chain, including brand name manufacturers, clothing, domestic tourism, restaurant chains and department stores on the consumption end and resource companies on the other end. When analysing an individual company, analysts are encouraged to adopt certainty, safety and growth as their top three considerations.

Quantitative risk analysis is an important part of the process and all three factors are combined to cover every investment decision the Pinpoint funds take. This gives the portfolio manager a clearer picture of the potential downside risk every single holding presents to him.

While Pinpoint could be seen as a China boutique, its ambitions go beyond that. With four actively managed funds already, and a private equity-based fund in the process of wind-up, it has shown itself capable of embracing more of a multi-strategy approach, embracing different themes and asset classes, and hiring in the requisite expertise when needed. This should stand it in good stead as Chinese markets continue to grow and mature