Avoiding Asia's corporate governance torpedoes

Wong Kok-Hoi, CIO of APS Asset Management, explains his firm''s investment approach.

Wong founded APS in 1995 as an Asian equities boutique servicing only institutional investors. The Singaporean firm broke even three years ago and has since become a favourite of the investment consultants. It now manages $2.6 billion.

What's your investment philosophy?

APS is a pure bottom-up firm. We don't do economic forecasting or political assessments. We don't look at charts or do quant modelling. We do primary research on companies. We believe if we can do research better than our competitors can, we will do pretty well every three years out of four.

What about asset allocation models, or top-down views, or quant screens?

The track record for those has been patchy. A lot of large firms are doing such work but the track record suggests it doesn't always work. Charles Ellis wrote a book on Capital Management in which he said he had yet to come across any investment firm that has profitably linked economic forecasting with portfolio management. In the past four or five decades, very successful investors like Warren Buffet and Peter Lynch have all been stock pickers.

The bottom-up approach is more reliable and produces performance on a more consistent basis. There is no empirical evidence that other methodologies are superior: not asset allocation modelling, not technical analysis, not quant models. We're not reinventing the wheel at APS. If a company continues to be profitable, the share price must go up. We have yet to come across a market that has not followed this rule.

How do you value stocks?

That's a tough thing to do because the future is unpredictable. For many companies, we use the discounted cash-flow model. We also use price-to-book versus return on equity or return on invested capital, and sustainable earnings growth. But if earnings are cyclical, we won't use the DCF model because we want to buy these when things are very bad, when the stock has collapsed and analysts are bearish. But when things are good and the share price has gone up fivefold, it's time to exit. In these cases the DCF model is useless; you could estimate the cash flows for 20 years and it wouldn't do you any good.

What kind of mistakes can you make?

The common ones are misjudging managements and a company's corporate governance. We've overestimated the ability of management, or didn't anticipate management to make decisions to the detriment of minority shareholder interests. We're very careful in assessing the honesty, competence and skill of management and their corporate governance practices.

We tread very carefully in China. Korea is improving but some issues remain. Taiwan's improving. Indonesia and the Philippines are difficult markets. The better markets are Australia, Singapore, Hong Kong and Japan.

What's the state of play in transitional markets like Korea and Taiwan?

Managements are now more conscious of the need to protect shareholder value. One example of bad corporate governance is LG Card. The company had to be restructured following huge losses in delinquent loans. It is now clear that the restructuring was done with the creditor banks' interest at heart, and at the expense of minority shareholders. In the second round of debt/equity swaps, the banks' debt was swapped into shares at a 40% discount to the prevailing market price.

This is like a related-party transaction, because the banks are also LG Card's creditors and shareholders, and as the majority, they could determine the terms of the swap. What kind of corporate governance is that? Equity investors lost more than 99% of their money in the company.

Ouch. How do you handle these situations?

You need experience and skill to avoid touching these torpedoes. You really need to cross-check facts.

Where do you source your information?

For historical data we rely on third parties like Bloomberg, annual reports and brokers. For information on honesty and competence of management, we try to check with a company's competitors, customers and suppliers. Future earnings estimates we do in-house.

How do you pick stocks?

We seek stocks riding on long-term structural trends that will last five to 10 years. Our second source is out-of-favour stocks and we get this inspiration from Benjamin Graham.

We look for strong managements and companies whose core competencies are not easily eroded, and which are therefore profitable. We look for companies with strong business models and high barriers to entry. In Asia, many such companies are found in the manufacturing sector - not the service sector like banks, telecoms or property. Many Asian manufacturing companies will be competitive for the next 10-20 years.


Their costs are and will be the lowest in the world. Asian eyes and hands are physically well adapted to manufacturing. I'll visit a factory in China and see thousands of workers on a production line. They're young operators in their twenties, with good eyesight and nimble fingers, and their productivity is high.

The best stocks are not necessarily tech stocks. We have no tech names in Taiwan. We like manufacturers of conventional products like shoes, faucets or golf club equipment. Amongst them we like companies that manufacture products against competitors in the US or Europe.

For example, Globe Union in Taiwan makes faucets for the American market. Most of its competitors are US manufacturers, or companies in Asia that are a fraction of Globe's size. This company will continue to grow its market share.

Another one in Taiwan is Fu Sheng, which makes titanium golf club heads. Its global market share is 40%. Every major golf equipment company in the world buys heads from them. In the past, these were made in Japan and the US. You tell me: who will make more money?

What about similar stories in services?

We like some service outsourcing like IT in India, but the share prices are already expensive. Services are quite varied and it's difficult to generalize. We need to look at the product being outsourced. Some have low barriers to entry, like call centres, and those we avoid. Pharma companies do have barriers to entry. There are a few in China but they're still a few years behind those in India.

You said you avoid banks.

Yes. The incumbents must now compete versus international banks by improving service and lowering their prices. It's the same for stock broking: the barriers to entry are low and they're offering a commodity.

You mentioned China is tough to navigate. What do you do there?

A few months ago we began researching China A-share stocks. We have a $60 million A-share fund. We're excited about the long-term prospects, but it's a most challenging market to research. We've got an office in Shanghai and a six-member team. We have QFII access via a few brokers. We do our own research and stock picks.

This effort requires first-class research. China has 1,200 companies, and only 10-20% are investable. We're searching for 30 or 40 well-managed companies with strong business models.

So is every domestic Chinese fund manager, or so they tell me. The universe of good companies seems well defined. How do you differentiate?

We generate our own ideas. Consultants like us because our portfolio contains names they didn't hear before. Others have Hutch and Singapore Airlines, but Global Union and Fu Sheng are not common names. I'm sure the names in our A-share portfolio are different from other Chinese managers'. But it's only a few weeks old, so it's too early to compare.

Isn't China's market overvalued?

The common view is that the A-share market is overvalued, with PE multiples of 20-25x. But we're investing there for earnings over the next 10-20 years, not two or three. We're investing in growth, so we must use the DCF model. If long-term growth is 8-9%, then China is by no means expensive.

Because of poor corporate governance, poor disclosure and political risk, we use a higher risk premium in order to discount cash flows to present value. If corporate governance improves like we've seen in Japan, Singapore and Hong Kong, then the discount rate will decline, which boosts your DCF value.

Singapore's market sold at 30x PE or higher in the 1960s and 70s and looked very expensive. But people were buying growth. If you had bought Singaporean stocks 30 years ago and sold them today, you'd have made a lot of money

Share our publication on social media
Share our publication on social media