VL Asset Management Limited is a Hong Kong-based investment firm licensed by the Securities and Futures Commission of Hong Kong. The firm’s flagship fund, VL Champion Fund, a long/short equity growth portfolio with a ‘value investing with catalyst’ approach, has registered a net return of approximately 60% since launch in June 2009. The team’s success has been largely due to its early identification of investment themes and disciplined investment process. Its capability in conducting proprietary research has enabled it to spot undervalued and under-researched equities with potential catalysts to unlock hidden value.
Mr. Vincent Lam, co-founder and CIO of the firm, has over 17 years of experience in financial analysis, investment research and active fund management in Hong Kong and China. Before founding the current company, Vincent was Managing Director of Ramius Capital Asia and CIO of Quam Asset Management. He was also once a financial journalist in Hong Kong and visited companies and wrote analytical reports.
- Please share with our readers a bit of history about VL Asset Management Limited and your flagship VL Champion hedge fund.
- What were some of the opportunities that led you to set up a Greater China focused long/short equity hedge fund? What challenges have you faced so far when investing in mainland China markets?
- The VL Champion Fund was one of the top performing Greater China hedge funds in 2013, returning 23.88% during the year. Can you share with our readers some of your key winning themes during the year especially with reference to the long and short side of your trading book?
- As an equity long/short fund focusing on value-investing, what investment process does the VL Champion hedge fund employ? Could you take us through a typical transaction of the fund that will help illustrate your investment process?
- Does the VL Champion hedge fund employ leverage in order to enhance returns? How do you manage the fund’s gross exposure over time as conditions in underlying markets evolve?
Historically, the fund employs a low level of leverage which has never exceeded 50% of the fund’s NAV. The main leverage was primarily from the use of index futures and options for hedging purposes and company specific shorts. We are conscious of the borrowing costs of each short position, and will not build a position if the risk-to-reward ratio is not in the fund’s favour. We tend to close out positions quickly if the borrowing cost is high and the market trend is against our direction.
According to the PPM, the fund may borrow an amount equal to up to 100% of the latest NAV. However, our borrowing will not exceed 60% of the latest NAV as bounded by our Investment Guidelines. When we are extremely bullish on the market, the maximum allowed gross long exposure is 110%. There is no minimum net exposure limit. Therefore, if we believe the market environment is too uncertain to be suitable for investing, the fund can hold up to 100% in cash waiting for better market conditions.
We judge the stock market cycle with a number of measures, including but not limited to the P/B and P/E ratios of the benchmark indices. We tend to become extremely bullish when the benchmark indices get close to their historical low valuations and increasingly bearish when the ratios reach record highs.
- Can you share with our readers a rough breakdown of your investments across different industries? How has your sectoral allocation changed over the years and on average how long is the holding period for your investments?
- Further to the above, how do you allocate assets across different countries in the Greater China region? How has this allocation evolved over the years, and do you anticipate any changes in the near future?
- The average Greater China investing long/short equity hedge fund has seen relatively more volatile returns in comparison to its peers investing with a pan-Asia or global investment mandate. In this regards, how do you manage your risk and guard against drawdowns especially given the high beta of long/short equities hedge funds to underlying equity markets?
- What sort of investors do you wish to cater to with the VL Champion Hedge Fund? What should their risk appetite be and what time horizon must they have for their investments in order to achieve optimum returns? In this stead can you also share with us the rough breakdown of your investors?
- Following the CCP’s third plenary session, a number of market reforms are being anticipated in mainland China. Can you share with our readers some of your thoughts on the opportunities and challenges that you see in these developments?
- Finally, with the Fed on track to wind-down its QE program and liquidity conditions showing signs of straining in China, what is your near term outlook for the markets? Do you believe Greater China investing hedge funds can repeat their remarkable performance from the previous year in 2014 as well? Or will the impending ‘hard landing’ of China’s economy pull down the returns this year?
VL Asset Management Limited was founded by me and Adrian Wong, our Chief Operations Officer, in 2009. The other owner of the business is Victor Tsang who joined us as Portfolio Manager (PM) in 2011. Adrian used to be a solicitor and has long experience in listings and M&As. He has been an investor in the funds I managed dating back to almost 12 years ago. Victor began his career as a Research Analyst in 2000 under my guidance and has then performed key investment roles at Quam Asset Management, Ping An China Asset Management (HK) and CICC HK Asset Management. Having known one another for more than a decade, the cohesion has enabled us to work efficiently. The three of us have and will maintain significant investment in the firm and the fund. In fact, every year, part of the received performance fees is invested in the fund and currently, partners’ money represented more than 11% of the fund’s AUM.
The fund, launched in June 2009, aims to generate long-term absolute returns with less volatility than the broader market throughout the whole market cycle. We invest primarily in the Greater China market but also in other regions where we can spot companies riding on an accelerating globalisation trend and/ or changing the landscape of the companies/businesses we normally follow.
Our strategy has a long bias and our typical net exposure is between +65% and +85% in a bull market cycle, and approximately beta-neutral in a bear cycle. Companies with excellent corporate governance, clean balance sheet and sustainable business models are what we look for. We also seek short opportunities where stocks suffer from persistent de-rating amid deterioration in earnings or management issues. We tend to allocate more on mid and small caps as hidden values are more frequently found in this universe. However, since 2013, our exposure to large, mid and small caps has been more evenly distributed. For example, small caps represented about 44% of our total gross long in February 2014, substantially down from 74% in February 2013. (We adopt the MSCI definition for market caps, i.e. small caps are those below US$ 2.2 billion.)
Where there is market inefficiency, there are opportunities. We believe there are persistent structural inefficiencies in the mainland China market due to a high ratio of retail investor participation. There is also a lack of culture to disseminate information in a fair and timely manner. However, as the Greater China markets become more institutionalised, we expect it to gradually become more efficient. In fact, the Greater China stock markets are rather momentum-driven giving rise to re-rating and de-rating potential of stocks. Second, China’s economic growth remains secular as its GDP growth is expected to stay at a mid-to-high single digit. What’s more, corporate activities are lively in the region given Hong Kong’s ready access to capital. M&As, business restructuring, asset injection and privatisations all lead to investment opportunities affirming our event-driven approach.
While we strive to have frequent dialogues with listco management and research the companies using the scuttlebutt method, there are times when it is difficult to conduct comprehensive due diligence on certain mainland companies. In that case, we will be forced to skip the investment targets if we cannot secure sufficient conviction in them.
Historically, our fund invests largely in Hong Kong-listed companies for their higher degree of transparency. Take end-February as an example, our portfolio’s net exposure was 81.2% and among that, Hong Kong listed companies accounted for 49.8% while China ‘B’ shares represented only 7.5% and we had not held any China ‘A’ shares which are rather costly due to limited QFII quota.
2013 was without doubt a challenging year - the MXCI China Index finished marginally up by 0.43% but was down by more than 20% at the beginning of the year. To us, focusing on our strength - stock picking with a catalyst and disciplined investing - has helped carry the day. Since day one we have aimed to identify the right investment themes and quality stocks way before they become over-valued or over-researched. TMT, healthcare, and green energy are some of the sectors played out in 2013 and we are early bird investors in those sectors – definitely not due to luck but our insights and research capability. For TMT, we have a long-held investment view in the global TMT recovery story (which we started with our investment in SUNeVision in 2009, then SmarTone & Hutchison Telecom Hong Kong in 2010-2011, and in NetDragon and Softbank in late 2012 to 2013). All of these positions have generated very decent investment returns for our fund. Shares of Softbank, the largest shareholder of Chinese eCommerce giant Alibaba which is on the verge of history’s largest tech IPO, rose 1.9 times in 2013. We took some profit but the stock remains one of our core holdings.
On the short side, we targeted companies suffering from a structural deterioration in earnings or financials. For example, we were particularly concerned about inefficiencies and oversupply in China. In light of the potential decline in the growth of fixed asset investment, we shorted heavy machinery makers such as Lonking from which we took a 26% investment profit. Similarly, we shorted Silver Base, a Wuliangye distributor, as the business environment for baijiu (Chinese liquor) grew tough due to the Chinese new leadership’s anti-corruption campaign.
While we generally look for catalysts for our investments, we care more about how our target company can benefit from the ever-changing business environment. We will also ask a more long-term question - in the next five to ten years, can this company adapt to these changes and survive as competition grows fiercer?
Urbanisation is an influential factor to China’s economic development and from this notion we formulated the e-commerce investment theme and were further inspired by the fabulous online trade figures – online transaction value in China surged from RMB26 billion in 2006 to RMB1.3 trillion in 2012, but this represents only 5% of total China’s retail sales. Alibaba, the owner of Taobao (C2C, 70% of market share in China) and T-Mall (B2C, 50% share), is an apparent winner. Though Alibaba is not yet listed, we discovered its results in Yahoo’s annual report and that Softbank was also 30-percent-owned by Japan-listed Softbank (now 37%).
We made a comparison between Yahoo and Softbank and found that Softbank, backed by stable telecom business in Japan, is more energetic and visionary and deeply undervalued based on three well-defined catalysts – (1) Alibaba’s prospective IPO; (2) the turnaround of US telecom sector as it was planning to acquire U.S.-listed telecom operator Sprint; and (3) the booming Internet culture as Softbank has various investments in tech ventures such as holding a 40% stake in online game developer Gungho whose share price soared 12 times in 1H 2013. Apparently Softbank is betting on the mobile internet business which we think the strategy is sound, and this technology and development is going to change users’ behaviour in the long-run.
Our SOTP valuation reports and relative value reports indicated that Softbank’s financials are convincing and that our initial target price of 44% upside was in fact conservative given its P/E at 9.5X, P/B at 2.3X and ROE at 23.9%. When we built this position in November 2012, it accounted for just 1.5% of our portfolio and the position was gradually built up to 4.2% by February 2013. Due to organic growth and a further top-up in May 2013, the position grew to more than 7% in August and we took partial profit.
In mid-2013, I took a trip to Japan visiting a number of listed companies there. Though we did not have a chance to meet with the Softbank management, it is a highly transparent company that its corporate information and business development plans can be viewed from its website and we never miss its quarterly results or any specific events. Its chairman is a public figure and updates on him can be searched easily. Also, our frequent dialogues with the Tech Analysts, both based in Japan and Hong Kong, of our prime brokers help us gain more knowledge in the industry. That said, for other smaller companies we will normally pay them a visit before making a judgment.
We invest based on each position’s specific merit. We do not believe in the historical correlations between different positions as they may change dramatically over time. However, to reduce exposure risk to certain sectors that may share the same macroeconomic risks, we have a sector allocation capped at 35% of the fund’s NAV.
As a general reference, TMT has always been our most heavyweight sector since launch, followed by utilities in the first half of 2013, financials and real estates in the second half of 2013, cyclical goods/services and real estates in 2012, cyclical and non-cyclical goods/services in 2011.
For our most convicted investments, the holding period can be indefinite as long as their valuations are justified by their fundamentals. SUNeVision is a long-held stock that we like given its solid fundamentals and resilient growth story and we have been holding this position since October 2009. For those that we have less conviction, the holding period is from six to 18 months.
By Greater China region, we mean Hong Kong, mainland China and Taiwan. Hong Kong-listed companies, with better corporate governance and transparency, have got our largest geographical allocation since launch, whilst China ‘B’ shares usually represent less than 10% of our total allocation. We did not invest in China ‘A’ shares since mid-2011 due to the high costs for the QFII quota and that we found when comparing the same company which offers both ‘B’ and ‘A’ shares, the former is always cheaper. For Taiwan, we had not re-entered this market since an exit in late 2009 as we find more interesting opportunities from the Hong Kong and China stock exchanges.
Since the fund’s inception, Hong Kong and China together always represent more than 50% of our total allocation – in fact, for most of the time, more than 90% of the total. Having said that, from day one we have never marketed ourselves as a ‘China-only’ manager as we foresaw that there could be opportunities outside the region where we can spot companies riding on an accelerating globalisation trend and/or changing the landscape of the companies/businesses we normally follow. Over the years, occasionally we do have a single-digit exposure in companies listed overseas say in the US, Japan or Germany as we could identify stocks matching our investment themes.
For Japan, we first bought into this market in November 2012 with a 1.5% of the fund’s NAV in Softbank along the line of our long-held investment theme in the global TMT recovery. The position was gradually built up to 4.2% by February 2013, but due to organic growth and our addition to a couple of smaller positions other than Softbank (whose share price soared 1.9 times in the year), it has grown to 8% as of September 2013 and 29% as of December 2013. As of the end of February 2014, our fund’s gross long was 110% and the breakdown was 86.1% in Hong Kong and China, 21.1% in Japan and 2.8% in Germany.
At all times, at least 50% of our total NAV will be allocated to the Greater China market and we anticipate the weighting should be approximately 70%-90% under most circumstances, while the remaining 10%-30% will go to regions outside China depending on the opportunities available.
Our expertise lies in identifying undervalued and under-researched stocks and it is often the smaller and mid-caps that offer the biggest opportunities for value growth. Our non-benchmark allocation means we can enjoy a low beta to the underlying equity markets – historically, our monthly average beta with the Hang Seng Index (HSI) is 0.75 and the past 12-month average is 0.61. Our historical beta to the MSCI China Index is 0.51 and the past 12-month average is -0.08. If you look at our portfolio’s weighted average beta with the HSI, it is even lower – the past 12-month average is 0.48.
Risk management is our top agenda and we strive to minimise volatility by adjusting our market exposure and by increasing our hedging through futures when we foresee escalating market downward risks. Also, we may adjust our geographical exposure. For example, we added Japan-listed stocks last year and that has significantly reduced single market risk and minimised month-on-month volatility. If you recall May, June and December, the HSI was down 1.52%, 7.10% and 2.41% respectively but our fund bucked the market downtrend and rose 5.77%, 1.97% and 3.33% respectively in those months.
Our business philosophy stems from the belief that with a combination of our proven stock selection skills and insights to identify market trends, we can generate absolute and consistent returns over different market cycles and environments and provide superior downside protection to our investors. We wish to help professional investors, including but not limited to family offices, institutions, pension funds and high-net-worth individuals, to grow their wealth. Our company’s partners, directors and staff have also invested in the fund, which means we eat our own cooking! As of the end of February, approximately 11.4% of the fund’s NAV is composed of in-house money, another 20.3% is from family offices and the remaining 68.3% is high-net-worth individuals. We do not have any funds of hedge funds investors at present but there have been on-going dialogues with them.
China targets an unchanged 7.5% GDP growth in 2014 and we believe this is not unachievable given her ever-increasing household consumption power and the determination of the new leadership, and the effective execution of cutting luxury government spending over the past quarters has already demonstrated their commitment to reform the economy. To us, stable growth means more sustainable growth.
In light of China’s ageing population trend and the rising affluence of the middle class, we believe the healthcare and pharmaceutical, consumer discretionary and staple as well as e-commerce and mobile Internet sectors should be the winners. On the other hand, with China’s declaration on a ‘war on pollution’ and plans to roll out a number of reforms, environmentally friendly companies including wind and natural gas should benefit in the long run. We are early bird investors in the above sectors and we will exert further effort in researching these areas.
Meanwhile, we are glad to see more signs of the banking sector reform, such as the interest rate liberalisation and the granting of commercial banking licenses to the private enterprises. In a way, this policy will permanently change the profitability of the state-owned banks, and this could be short-term negative to the stock market as the majority of the key benchmark indices remain heavily overweight in the PRC banking sector. However, in return, the new banking sector reform should be able to redistribute these formerly windfall profits from the state-owned banks to the depositors (and thus the general public) and the private sector.
Undoubtedly, there remain a lot of uncertainties in China such as overcapacities, shadow banking and corruption, but these may have been at least partially discounted by the currently depressed valuation. The new economic reforms may cause short-term pains to the state-owned enterprises (SOEs) but in the longer run, it will help improve the operating efficiency of the SOEs and revive the private sector. We expect more Chinese companies to refocus on profitability and shareholder values instead of the present sole focus on gaining market share.
For years, China’s growth has been driven mainly by unproductive fixed asset investment (FAI) rather than internal consumption. While top line growth and GDP growth have been encouraging, we care more about profit margins and the quality of earnings and that explains why we count on the corporate balance sheets rather than rely on unclear or short-lived policy signals.
In brief, we are positive on the long-term impact of the series of reforms to the economy in general, and to the private sector in particular. While we will continue to identify other undervalued or under-researched sectors/stocks that may benefit in echo to the socio-economic conditions in China, we will seek out short opportunities particularly on companies suffering from structural problems or deteriorating cash flows.
The US tapering is likely to add pressure to Chinese exporters but the resilient domestic consumption power should help China to sustain its growth. The tapering may affect international fund flow but China herself is flexible and independent enough to expand liquidity any time as she deems fit. People have been debating on a possible ‘hard landing’ of China’s economy but we believe China has been doing a good job in reforming its economy gradually, as demonstrated by its sustainable GDP growth in recent years despite all the challenges.
Similar to 2013, sector and stock selection will remain crucial to making profitable investments in 2014. Greater China-themed managers may not be able to repeat their good performance if they cannot generate alpha. To us, we are confident that we can continue to deliver superior risk-adjusted returns to our investors as our edge is stock selection and that our catalyst-driven strategy can well benefit from the current market environment where M&A, turnaround or re-structuring events abound.