Value Partners hunts inside specific sectors

Asset Class in Focus

Facing China’s headwinds, the firm is positive on value plays in three equity sectors that have been beaten down.

Chinese equities had a terrible 2018, with the MSCI China returning -18.7% and the MSCI China A Onshore Index -32.8%.

Negative investor sentiment was driven by slowing global growth, particularly in China, which last year had the weakest GDP growth since 1990. The US-China trade conflict helped to further dampen sentiment.

Additionally, this year, corporate earnings across the board “are set to be squeezed”, said Kelly Chung, senior fund manager for the firm. “We expect further downward revisions to earnings estimates for the MSCI China, MSCI Asia-ex-Japan, MSCI Japan and MSCI USA indices.”

Yet concern over escalation of the trade conflict appears to be easing and senior fund manager, Philip Li, said that “valuations for most sectors of the MSCI China are trading at close to 10-year trough levels on a price-to-earnings basis.

“In fact, the A-share market‘s valuation has become one of the lowest among global stock markets at 10 times 2018 earnings.”

The big plunge in A-share valuations, which has also been noted by TT International, has Value Partners combing sectors for value plays.

Three sectors

Li was particularly optimistic about the healthcare sector.

One driver is China is a rapidly aging population: on average 5 million people every year turn 65, when statistically they become more vulnerable to illness, he said. At the same time, people are increasingly demanding better quality drugs and healthcare services, yet healthcare spending remains low at 1% of GDP.

“We see the sector has structural growth,” Li said.

Philip Li, Value Partners

Headwinds include steep cuts in drug prices. He explained that last year, 11 cities banded together to bulk purchase drugs. This Group Purchasing Organisation, or GPO, drove down drug prices as much as 90%

“There is a widespread belief that all drugs will have a 50%-90% price cut and the sector will then collapse.”

However, he believes good bets are some individual companies with only 3-4% exposure to drug price cuts but with a share price collapse of 50%. For example, pharmaceutical companies focused on targeted cancer drugs, which require decades of research partnerships with global companies, testing and research in China and overseas. “These companies less subject to drug price cuts.”

The firm’s China Convergence Fund, which holds mainly A-shares, has 26% of the portfolio in the healthcare sector.

Li also mentioned two other sectors where the investment team believes they can find value plays.

One is China’s higher education system, which can’t accommodate all those who want to attend university.

“China needs to establish 75 more colleges and universities. It’s a structural demand and it is underserved.”

Regulatory uncertainty surrounding education has been a negative, but Li believes regulations are about to be clarified.

Another sector is the internet. Valuations have become more attractive after the sector’s underperformance last year. During most of 2018, there was a licencing freeze on new titles in the gaming industry, which suffered its slowest growth in a decade.

However, gaming approvals have resumed in 2019 and “e-commerce continues to disrupt retail and enjoy growth drivers stemming from new retail such as fresh foods and China’s consumption upgrade”, the firm said.

Alibaba is the China Convergence Fund’s largest holding at about 10%.

Bullish sentiment seems to be mounting for Chinese equities, despite headwinds. In the last quarter of 2018, Chinese equities had the most votes for an increase in allocation among Hong Kong fund selectors, out of 26 asset classes, according to the latest asset class survey by Last Word Research.


The Value Partners China Convergence Fund vs the benchmark and sector

Source: FE. Three-year cumulative returns in US dollars.

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