Morgan Stanley Investment Management recently warned about a bubble in the onshore market, as the amount of money that inexperienced and first-time investors are borrowing on margin to buy stocks is uncomfortably high.
Chinese retail investors are trying to play the valuation gap between China’s A-shares and their identical H-share counterparts listed in Hong Kong. As a result, the onshore liquidity is now flowing into Hong Kong shares too.
Meanwhile, China and Hong Kong regulators have announced the July 1 launch of the mutual recognition of funds initiative, which will allow cross-border selling of funds to retail investors.
Further market developments such as the Shenzhen-Hong Kong Stock Connect and the likely inclusion of China A-shares in the MSCI global indices are expected in the coming months.
Amid these developments, Fund Selector Asia takes a look at the Baring Hong Kong China Fund and the Fidelity China Focus Fund.
The Baring fund, launched in December 1982, has a longer track record compared to the Fidelity product, which has been in existence since August 2003.
Despite its longer track record, the Baring fund is smaller, with $2.6bn in assets under management on 30 April. The Fidelity fund is nearly double in size with $5.3bn in AUM on 30 April.
The Baring fund seeks to invest in companies listed on Hong Kong or China stock exchanges. It can also invest in Taiwan companies.
Likewise, the Fidelity fund also aims to invest at least 70% of its assets in China and Hong Kong companies, while it can also invest outside these two main geographies.
Worthwhile to note is that both funds have had new managers since 2013.
Laura Luo, who was earlier with Schorders, started managing the Baring fund in September 2013. Ning Jing, who was previously with BlackRock, took charge of the Fidelity fund in November 2013.
While both funds have a similar investment universe, their investment styles differ. The Baring fund focuses on growth stocks while the Fidelity fund has a value-biased investment style.
Germaine Share, manager and research analyst with Morningstar Investment Management Asia, provides a comparative analysis.
Investment strategy review
A lot of changes have happened to the investment process of the Baring fund since Jean-Louis Scandella took over as the new head of global equities in June 2014, Share said.
The Baring fund continues to focus on stocks that exhibit growth at a reasonable price, but now Scandella has laid out a defined scoring framework for analysts to rate stocks on three factors: quality, growth and upside.
Quality is measured in terms of a company’s management competence, balance sheet health, franchise strength and alignment with shareholders interest.
Growth is defined as companies with 10-20% compounded annual growth rate in earnings over the past three years, and CAGR going forward during one year and five year periods. Upside is measured by a discounted earning model, which helps analysts in determining forward 12-month targets.
“Scandella’s changes have impacted all equity fund portfolios managed by the Baring team. While we think these changes make sense, we also question whether individual portfolio managers have that much discretion while running their portfolios,” Share said.
Among other changes, Scandella also wants portfolio managers to have a longer investment horizon of three-five years. It has been one-two years, Share said.
Due to this, Morningstar expects the portfolio turnover of the Baring fund to come down.
In regards to the Fidelity fund, Ning “is known as a value manager,” Share said.
“We like that she is still using the value discipline even though Fidelity is more known to be a growth investment house. Most of Fidelity’s funds have a growth bias.”
Ning’s main emphasis is on value stocks and she also uses a contrarian investment style.
“Her first step in the investment assessment process is to screen all stocks in her investment universe using a valuation screen. Having screened those stocks, she would look for stocks that have a growth potential. But I will not label her as a growth manager. She is looking to buy cheap stocks.”
In terms of the country-orientation, both funds have predominantly China exposure. However, the Baring fund has a relatively higher exposure to Hong Kong than the Fidelity fund.
Sector-wise, both funds have significant exposure to financial companies and hold nearly similar weighting to industrial companies.
There is some overlap among their top 10 stock holdings with both funds holdings Tencent, China Construction Bank, Ping An Insurance Group, China Life Insurance, Industrial and Commercial Bank of China, and China Petroleum and Chemical.
A snapshot of portfolio allocation:
Source: Fund fact sheets on 30 April.
Performance review
Since Luo took charge of the Baring fund in September 2013, the performance has been mediocre compared to the Fidelity fund.
Between 1 October 2013 and 30 April 2015, the Baring fund returned 21.9%, lagging the category and the MSCI China index by 231 basis points and 254 basis points, according to Morningstar data.
“We do like to assess the performance over a full market cycle, which is three-five years,” Share said.
“Given her track record on her previous fund [about seven years on the Schroder ISF China Opportunities Fund], we are optimistic she will be able to deliver over the long-term.”
By comparison, Ning has been outperforming since she took charge of the Fidelity fund, Share said.
Between 1 November 2013 and 30 April 2015, the fund returned 27.8%, outpacing the MSCI China Index and category by 394 basis points and 357 basis points, respectively, according to Morningstar data.
“The market right now favours value stocks. That is the reason why the Fidelity fund [value style investment] is outperforming while Luo [the Baring fund manager] has a quality growth style.”
“When the market is growth-driven, then the Baring fund would do better.”
As for downside protection, both Luo and Ning are fairly new to their funds.
“However if we look at their track record on their previous funds — the Schroder ISF China Opportunities and BGF China, respectively, — we see that Luo had a downside capture ratio of 92.65% while Ning had a downside capture ratio of 95.05% over a five-year time horizon at the end of June 2013.
“If they were to execute the same process as they have in their previous funds, neither funds would be particularly downside resilient,” Share said.
A look at performance over various periods until 31 May:
The Fidelity fund has also outperformed the Baring fund over all calendar years except in 2011, as seen in the table below:
Source: FE AnalyticsIn 2011, both funds had similar negative returns.
Although the Fidelity product has performed well, Share said it will be interesting to see what happens if the product underperforms. “We would like to see whether Fidelity, being a growth-focused house, would change Ning’s investment style.”
Manager review
As mentioned previously, Laura Luo has been managing the Baring fund since September 2013.
Luo is the head of Hong Kong China equities at Baring and is responsible for leading the Hong Kong-China equity investment team. She was previously with Schorders Investment Management and managed the Schroder ISF China Opportunities fund from February 2006 to July 2013.
“She had a good track record on Schroder ISF China Opportunities Fund. At Baring, she has access to fewer resources. The analyst team is small, comprising five people.”
Share was concerned with personnel changes at Baring.
“They lost their A-share manager, Winston Ke, in March. In addition to the local team changes, they also had a change in their global head of equities (Scandella in June 2014 as mentioned earlier).”
Jing Ning has been managing the Fidelity fund since she joined the firm in November 2013. Jing has managed Chinese equities for nine years. Previously, she worked with BlackRock and managed the BGF China Fund from 2008 to 2013, according to FE Analytics.
Share likes both managers. But she said Ning has better support due to a much larger team with 26 analysts.
Fees
The Baring fund charges lower annual management fees of 1.25% compared to the Fidelity fund’s 1.5%.
The total expense ratio (TER) or the ongoing charges for the Baring fund was 1.78% for the year ended 31 October. The TER for the Fidelity product was 1.93% for the year ended 30 April.
Fees are cheap for both funds compared to the category median of 2.2%, Share said.
Due to its cheaper pricing, the Baring fund has an edge in its competitive sphere.
Conclusion
Morningstar evaluates funds based on five pillars: people, process, parent, performance, and price, with analysts assigning a rating of positive, neutral, or negative to each pillar.
For the Baring fund, Morningstar is positive on people and price and neutral on the other three (process, performance and parent).
The Fidelity fund gets a positive rating on three pillars (process, people and parent) and two neutrals (performance and price)
That accounts for the difference in Morningstar ratings. The Baring fund has a “Neutral” rating and the Fidelity fund is given a “Bronze” rating.
As a result, Morningstar prefers the Fidelity fund over the Baring vehicle, Share said.
“We do like the Baring fund manager [Luo]. But we are a bit concerned about the stability of both local and global teams and also the changes in the investment process. We are more comfortable with the stability of the Fidelity fund.”
“We like Ning [Fidelity manager] a lot. She is settling well in her new environment and making good use of the sizeable analyst team around her.
“Despite moving to a growth-oriented shop, she is still sticking to value discipline and delivering well.”
A point to be noted is that Ning personally invests in the fund, Share said.
“This is not something very rare [among managers] but it is something that we like. By investing into her own fund, a portfolio manager’s personal financial interest is more in-line with investors’ and she would have better incentive to deliver on performance,” Share said.
