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How to find alpha in China equities?

Chinese companies undergoing business strategy changes may provide 'phenomenal' investment opportunities, according to Caroline Maurer, head of Greater China equities at BNP Paribas Asset Management.
Caroline Maurer, BNP Paribas Asset Management

Hong Kong-based Maurer, who manages the firm’s Parvest Equity China Fund, invests in quality-growth companies, which typically are industry leaders.

These companies, which Maurer calls “moat growth” companies, should provide better downside protection for investors in China’s volatile market.

However, she believes that these companies do not provide much alpha.

“Moat growth companies are the foundational core of the fund, taking up around 60-70% of the portfolio. But their contribution to alpha generation is only 20%,” she told FSA in a recent interview.

To offset that, Maurer explained that she also looks at “transformative” companies, which account for up to 30% of the portfolio.

“Their proportion in the portfolio is small, but their alpha contribution is around 60-70%.”

The fund’s investment universe is the Greater China market, which includes both onshore and offshore stocks. It is fairly concentrated, holding around 48 names, according to Maurer.

Business model changes

Transformative companies are typically those that are changing their business models or strategies to expand market share, according to Maurer.

“When they start to change, you can start pricing in some of the future potential development as they are expected to have better competitive positioning in a given industry.

“If you get it right, over time, the share price performance tends to be phenomenal,” she said.

Although there are not a lot of transformational companies in China, they can be found across industries, even in traditional sectors like banks and cement.

For example, the firm is invested in a bank that expanded its services to retail borrowers from just lending to small-to-medium enterprises. Another firm is a camera lens manufacturer, which started to invest in technology and expanded its client base to car manufacturers from just smartphones.

However, investors should be cautious of valuations as their share prices go up, Maurer said.

“It could get to a point where valuations become too stretched because everyone gets too excited and puts a much higher multiple on a stock. When that happens, we think of starting to take profit [and trim positions].”

Small positions

Investing in transformative companies comes with the risk of these companies not delivering on strategic plans.

Because of that, Maurer looks for detailed business plans and management which always communicates about progress toward goals.  “[Management] should also communicate whether they have gotten customers from new channels.”

Given that transformation takes time to unfold and may not always be linear, the size of an initial investment is typically small.

“The stake should be built over time after communications with management frequently. I would think it is dangerous to have high conviction levels on day one.”

The Parvest Equity China Fund versus its benchmark and sector in Hong Kong

Part of the Mark Allen Group.