HEAD-TO-HEAD: First State vs Principal

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Both funds invest in Hong Kong-listed companies that tend to have exposure to China. But there are huge differences with regard to their investment focus, investment horizon and benchmarks.

The First State fund is quality-focused, according to Share. That means that the fund manager focuses on the trust-worthiness of a company’s management team and corporate governance, such as transparency of business strategy and accounting practices.

Share noted that the quality focus is common to First State funds. “If you look at their EMEA funds or their regional funds like Asia equity, they have this same focus on equities.”

The First State fund also has an investment horizon of three-to-five years, which means portfolio turnover is low, Share added. It also runs a concentrated portfolio of around 40 names. The fund has no benchmark index.

By comparison, the Principal fund has more of a quant-base investment process, which the firm calls the “global research platform”. The platform screens all the stocks in its investment universe using quantitative filters such as one-year earnings growth, Share explained.

In addition, the Principal fund has its own custom benchmark index, which is 92% of the BMI China and Hong Kong and 8% of an individual stock — HSBC. The custom benchmark index has around 1,000 constituents.

The fund’s benchmark is unique because the BMI China and Hong Kong Index is an existing index not commonly used by fund managers, according to Share. Usually, Hong Kong equity-focused funds that have a benchmark would use the Hang Seng Index.

The 8% weighting in HSBC is not surprising, given that HSBC is a big part of the local market and accounts for 10% of the Hang Seng Index, she added.

As a result of the quantitative process and the benchmark, the Principal fund has a more diversified portfolio of around 70 names. The screening process also has a focus on one-year earnings revision, which means it has a shorter holding period of one year compared to the First State fund (three-five years).

The differences in the two funds’ investment processes and benchmarks explain the differences in their sector allocations.

Sector allocations

Source: Morningstar 

Given First State’s focus on quality, the fund steers away from certain companies, such as China’s state-owned enterprises, which tend to have poor corporate governance and less management expertise compared to private sector firms, according to Share.

For example, the fund has low exposure to Chinese banks and real estate companies, which dominate the Hang Seng Index. The Chinese banks listed in Hong Kong are usually state-owned enterprises, she said.

First State likes stocks that are linked to the China consumption story, which explains its huge allocation to consumer stocks, according to Share.

The fund manager also likes healthcare because of a long-term growth trend. China’s population is not only aging, but as the middle class evolves people are demanding better medical care than they currently have.

On the flipside, since Principal has a benchmark index, it has huge holdings in banks. In addition, given that the fund’s investment process is not locked into a quality approach, the manager is open to investing in Chinese state-owned banks such as ICBC and China Construction Bank.

Share added that Principal likes banks because non-performing loans have stabilised and the sector is trading at an attractive valuation.

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