[Awards Q&A] Best Hong Kong Equity Fund - First State Hong Kong Growth Fund

Significant purchases over the year included Tsingtao Brewery on attractive valuations. The company has a strong brand franchise, a solid balance sheet and generates high levels of free cash flow. The Fund also purchased Hengan, a leading producer of tissue paper products, sanitary napkins and disposable diapers which had fallen on general market weakness. With mid-single digit revenue growth and a modest recovery in margins, the risk-reward seemed reasonable. Li Ning was divested on expensive valuations and concerns around insider selling (the founder indirectly disposed of a 6.8% stake, held through Viva China).

Key contributors to performance included China Merchants Bank, as asset quality improved after the implementation of more conservative lending policies; and its high margin retail business grew strongly. Meanwhile, CSPC Pharmaceutical increased on the strength of its pipeline. The company has 25 innovative drugs in clinical trials currently, with aims to launch these over the next five years. Techtronic Industries rose, as demand for its cordless tools technology had grown rapidly in all key markets.

On the negative side, Tong Ren Tang Technologies declined, as production constraints led to lower sales volumes and decreased revenue. Dairy Farm International struggled with high operating costs and increased competition among supermarkets. However, CEO Ian McLeod’s commitment to improving efficiencies in the business is reassuring. Jardine Matheson fell, largely due to weaknesses at subsidiaries, Hongkong Land and Dairy Farm International.

Q2) What are some specific opportunities you have identified for 2020, and do you expect your 2019 outperformers to persist in 2020? What are the top risk factors that could impact your portfolio, and how are you positioned to mitigate these potential risks?

There is still significant uncertainty around Covid-19 and its potential impact globally. The situation could become worse before it gets better – and no one knows when the bottom will be. Despite the uncertain outlook, our investment philosophy and process remains unchanged. We invest with a 5-year investment time horizon in mind – and these kinds of events do not affect our investment approach. We continue to focus on buying well-managed businesses, with strong franchises and conservative balance sheets, which we believe have decent long-term fundamentals that can drive profit growth over the long term.

Though current events might impair earnings growth in the short term, we believe the impact on companies with strong franchises should be limited. Based on our previous experience with SARS, we believe the current negative sentiment could be a good opportunity to buy into companies with good long-term growth prospects.

Q3) In which areas do you think risk is over/understated with respect to (i) the outcome of the US Presidential election, (ii) persistently loose monetary policies by major economies, (iii) Coronavirus impact on global growth, and how are you expressing these views in your portfolio?

We are under no illusions about our ability to predict macro events, nor do we pay too much attention to the gyrations of the market. We prefer to spend our time researching companies and talking to management instead. We remain resolutely-focused on quality (of management, franchise and financials), which has helped our portfolios remain relatively defensive amidst the market volatility. While we understand that such periods are worrying for clients, they provide us with opportunities to top up our holdings and buy into quality companies at cheaper prices – thus contributing to better long-term absolute returns.  

Q4) How is your investment team organized? Have there been any changes to the investment team or structure over the past year? Do you anticipate adding to the team in the near future?

Everyone on the investment team is first and foremost considered an analyst and this includes all portfolio managers. Every team member performs a broad ranging investment analyst role and is encouraged to participate in the generation of ideas for all client portfolios.

While we have no specific hiring plans, we are always on the look-out for talent that share our investment philosophy and would fit with the team’s culture.

Q5) Where do you feel that the investment team or the investment process can be improved upon in the future?

We take great care to evaluate the investment team and our investment process on a regular basis to avoid falling into complacency. That said, our investment philosophy (which is centred on identifying quality companies, buying them at a sensible price and holding for the long term), has remained largely the same since the launch of the team’s first Asia Pacific equity strategy in 1988.

We place strong emphasis on high quality proprietary research and direct contact with the companies in which we invest. The consistency of our investment approach and our absolute return mind-set aims to avoid being influenced by the market – whether that be market euphoria or pessimism. Our reputation as successful long-term investors and the framework we operate means that are able to look past the quarterly numbers and focus more on secular drivers of risk and return.

View all 2020 Morningstar Fund Awards Hong Kong articles here.