Investor Dialogue: Yi Tang

The general manager of Edmond de Rothschild Asset Management in Hong Kong talks to FinanceAsia about not over-paying for growth and how the biggest investment risk is to not be in China.

How would you describe your investment philosophy?
We are value investors, a strategic focus that has been shaped by our history as a family-owned bank. It is a philosophy and discipline which we have applied successfully in emerging markets, including China, and means that we avoid chasing the market or taking positions without fundamental support. Our philosophy also allows us, at times, to take contrarian views. For instance, we took a big position in unpopular telecom stocks late last year, which started to perform this year.

In February, we started to reduce our holdings in small and medium-sized pharmaceutical companies because they were simply too expensive. We had held them for a long time, starting to buy them when they were trading at single-digit P/Es (price-to-earnings ratios), but they had subsequently surged to multiples of over 30 times. We still believe that the pharmaceutical sector will grow steadily over the next several years, but we cannot justify keeping them in our portfolios at their current valuations. Simply, our value discipline means we do not over-pay for growth.

And your style?
Our style is to focus on bottom-up stock analysis. We do not diversify for the sake of diversification, nor do we conduct "benchmark-plus" investing, in other words, we do not use a benchmark as a starting point to determine how much we should over- or under-weight each sector. The sector biases that can sometimes be observed in our portfolios are the results of our stock picking. For example, we currently have no Chinese banks in our portfolio, yet they make up around 20% of our benchmark index. When we make investment decisions, we aim for 30% to 50% returns for large caps and 80% to 100% returns for medium- and small-caps over a market cycle. For sectors that we like but where companies are often small with little operating history, such as in alternative energy- or environmental protection-related sectors, we also spread our investments across several companies to limit our risk and increase portfolio liquidity.

How does that translate into your process?
Investing is an art, not a science. Our firm has what I'd call a "fund manager culture", meaning that we have a structured process using quantitative tools that allows our fund managers to focus their efforts on fundamental research. We constantly update and review quant screens covering more than 900 stocks, and stock ranking tools using over 20 indicators ranging from valuation to financial health.

On the qualitative side, we have developed over time, an exhaustive checklist for analysing companies, covering management depth, history, the sustainability of the business model, among other considerations. We also have a uniform financial template for all companies that are in our portfolio. These internal research reports serve as the base for our Tuesday team meetings. As we have a uniform structure for our research reports and a written trail of all our meetings, discussion can be concentrated on the "art" part and investment decisions can be made quickly.

Are there specific problems investing in China?
Investing in China is no different from investing in any other fast-growing economy. New products and services are emerging, which makes investing exciting, but also exhausting at times. Chinese banks, telcos, insurance companies or railways are now big and on the radar of mainstream investors, while many of them were practically unlisted and unknown to most investors just five years ago. On the other hand, A-shares are largely over-looked and under-invested by global funds, partly due to the nature of QFII (qualified foreign institutional investors) regulations, which makes access to the market quite difficult.

What about the much-maligned property and bank sectors?
The property sector is quite complex. In the past we have been cautious, aware that developers were constantly bidding up the price of land in a way that was unsustainable. But the bubble is largely concentrated in the major cities, such as Beijing and Shanghai. The recent property tightening measures have mainly targeted the high-end segments in those cities. In the central and western regions, the urbanisation process is still on-going and living standards continue to improve.

Banks, which have largely been doing national service as the conduits for China's stimulus, have been out of favour lately, as investors recognise that these banks will need to raise capital. Both the property and banking sectors have under-performed the market since August 2009 and valuation has come down further after property tightening measures were announced in April, making them increasingly attractive for long-term investors. Companies in the materials sector also look over-sold.

So what is the biggest risk?
The biggest risk for investors is not to be in China. History is on China's side, as it was for Europe in the 19th century and the US for most of the 20th century. Many ideological constraints have been lifted in China in the past 30 years; great fortunes are being made and the country is becoming increasingly integrated with the rest of the world. The currency should appreciate from the third quarter of this year, and capital controls will gradually be eased. Most importantly, investors need to recognise that China is made up of many different factions, including regional and industrial interests and groups. Its diversity is likely to evolve in time into a more democratic and transparent political system.

This article was first published in the June 2010 issue of FinanceAsia magazine.

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