China is incredibly cheap right now both from an absolute and relative perspective, making it an opportune moment to launch a dedicated China equities strategy.
That is the view at least of Sandy Pei, portfolio manager at Federated Hermes, expressed during an interview with FSA after the US-headquartered investment manager launched its first dedicated China equities strategy only a few months ago.
“We resisted the temptation to launch products just because they were hot, whether it was India, growth, tech, ESG or whatever,” she said.
“But when you think about the timing for launching a dedicated China fund, it is actually perfect right now. You see how cheap the market is both from an absolute perspective and relative to other assets.”
According to its most recent factsheet, the MSCI China index is currently trading at a price-to-forward earnings ratio of 11.78x compared with, for example, a ratio of 21.43x for its equivalent Indian benchmark.
However, asset managers remain somewhat divided on China at the moment. While valuations are attractive, the regulatory crackdown appears to have peaked and some accommodation from the central bank remains on the cards, some asset managers argue that this is currently outweighed by the country’s zero-Covid policy.
In September, for example, UBS Wealth Management downgraded its outlook on Chinese equities to neutral from most preferred, citing in part the country’s zero-Covid policy.
According to Pei, not only do valuations right now make launching a dedicated strategy worthwhile, but it also makes sense as investors increasingly want to express their view on China specifically.
“If you think about how international investors access Chinese equities, they used to have access mainly through Asia ex-Japan equity and emerging market equity strategies, where it’s up to the fund manager to make a call about China,” she said.
“If you have a China standalone strategy, it’s much easier for an asset allocator to express their own view and provide that flexibility to investors.”
China
There is not much data currently on Federated Hermes’ China equity strategy given that it only launched in July, although it is down 15.58% since then to September 30 compared with a drop of 16.87% in the benchmark index during the same timeframe, according to its most recent factsheet.
Its top holdings are JD.com (6.08%), Tencent (5.76%), Alibaba (4.99%), Baidu (4.83%) and CK Hutchison (3.76%).
Its portfolio managers are Jonathan Pines and Pei, who are also portfolio manager and deputy portfolio manager respectively on Federated Hermes’ Asia ex-Japan equity strategy.
The Asia ex-Japan equity fund has consistently beaten the benchmark (see chart) since its inception, which Pei attributes to Federated Hermes’ stable team in part.
“We are quite unique in the way that Jonathan and I have been working together for 10 years and we have another three analysts. One of them has been working with us for six years and another two for three years and one year respectively. It’s a very stable team,” she said.
She acknowledged that there was a lack of data so far on the China strategy, although pointed to the fact that the Asia ex-Japan strategy had outperformed as evidence of the fund manager’s track record.
“If you talk about our track record, we beat almost all of our peers as well as the index for our Asia ex-Japan fund and you can’t outperform without getting China right given how big that is as a percentage of Asia ex-Japan,” she said.
Asia ex-Japan
Federated Hermes adopts a bottom-up approach to stock selection, although Pei noted that when one stock is cheap, the whole sector or country tends to be cheap so the asset manager often ends up with very punchy sector and country allocations.
Its Asia ex-Japan fund has its largest exposure to China at 39.15% compared with 32.32% for the benchmark. Korea is its second largest exposure at 24.16% versus 12.47% for the benchmark.
“Korea is a free meal right now. Similar to China, it is trading at almost historical low multiples and has been hurt by the perception that it is a cyclical market,” said Pei.
“But when you look at the semiconductor market, it is an oligopolistic market now so you see much better price discipline among the big players. The Korean automakers are generating record high market share in the US. We believe the market has very strong fundamentals and is being mispriced by the capital markets.”
The other notable call that Federated Hermes has made is with regards to India, where its Asia ex-Japan strategy has a weighting of just 0.68% compared with 19.06% for the benchmark.
“The Indian market has been re-rated substantially and is now even more expensive than the US market. Although comparing a country to a stock is difficult, we would argue, for example, that Google’s price to value proposition is more attractive than that of India,” said Pei.
“We like India; it’s a democracy, it has a low base, it has very favourable demographics. It has lots of opportunity because of trade tensions between China and the US. We agree on all of that. But if you believe there is a price for everything, India now is overpriced.”
