Vincent Lam has been Chief Investment Officer of QAM since 2002. He joined the Quam Group as a research analyst in 1999 and was promoted to Head of Quam Research in 2001. Before that, he was a financial journalist of two highly circulated local publications (1996-1999) during which he conducted interviews with the management of numerous listed companies and thus built up his knowledge on and network in different industries. Vincent holds a bachelor's degree in economics from Chinese University of Hong Kong and is currently reading an executive MBA.
Could you give us a brief overview of the Chinese A, B and H share markets, and recent positive policy changes therein?
For the merger of A, B and H shares, Beijing's consideration will be mainly the stability of the mainland's financial markets. There are still restrictions on QFII quota because the PRC government does not want a substantial influx of foreign capital, which may result in quickening the process of yuan appreciation.
But given the long-term goal of freeing up the financial markets, the regulatory bodies are already doing lots of work. The first step is to allow short selling, futures and warrant activities in the A share market. The regulatory body has approved the short selling of A shares, and futures and warrants will also be launched very soon. This is a strong signal of further relaxation of investment restrictions in the PRC stock markets.
The next step will be the merger of A and B shares. Since the CSRC has also stopped approving the issuance of new B shares, this market will gradually die down, and it is of first priority for the regulatory body to deal with this market ahead of further reforms. We therefore expect B shares to merge with A shares in the coming 12 months.
The merger between A and H shares will take much longer, and may not happen before mid-2008 as this will not take place until the yuan becomes fully convertible. The most optimistic prediction that the yuan will become fully convertible is by the Beijing Olympics.
For our strategy, since QFII quote is still very limited, we find it hard to do arbitrage between A, B and H shares. What we are currently doing is to buy B shares that trade at discounts to their A and H share equivalents in the expectation that a potential merger will bid up the prices of shares that we own. Should we have enough QFII quota, we may do long/short of the same companies expecting the gap to narrow upon the merger of B and H shares.
How is the emerging Greater Chinese landscape affecting hedge funds in the region such as Quam Greater China Segregated Portfolio? More specifically, how does your fund's investment process take advantage of these opportunities?
Like any other emerging markets, the Greater China region is vibrant, which may mean lots of opportunities to local experts but also certain risks to foreign investors who do not have thorough knowledge of the region. This is evident in the divergent returns of the Greater China hedge funds. We have been in the industry for more than ten years. We have built a solid background knowledge on over 500 listed companies in the region, some of which we have kept good relationship with the management for a fairly long time.
Our inclination to be a contrarian value investor also helped us identify the right investments at extremely good prices. Given that the PRC GDP per capita is growing at around double-digit growth rate, we are confident that the PRC property market is still in the middle of a secular bull market.
The central government's austerity measures in 2004-2005 have created a good opportunity to bargain hunt the PRC property developers. We believe that this will continue to be the case whenever there are any negative news in the market that drive valuations substantially downward.
Could you also discuss the above in the context of the returns posted by the fund since inception? How do you explain the sharp downturn in the fund's May returns?
You cannot be right all the time. Since the fund's inception in June last year, the fund generated a net return of 49% as at the end of September. Our target is to achieve the maximum risk-adjusted return. Our performance has been among the top five out of 38 Greater China hedge funds monitored by Eurekahedge, with an annualised standard deviation of below 18.5%. Given the performance we believe that the risk our investors are taking is more than justified.
We had substantially trimmed down our long book in the high beta companies since the middle of April. The market downturn in May turned out to be a bit larger that we had expected, but we substantially outperformed our peers in June mainly due to our timely action of topping up our long position again right at the bottom of the market in mid-June.
The fund has clearly outperformed the Eurekahedge Greater China Hedge Fund Index (up 28% for the first nine months of 2006), comprising of 37 China-focused funds. What portion of this would you attribute to Quam's investment process? In your view, what competitive advantage does your fund have over the other 36 funds?
We have a great team. I was born in Mainland China with the first three years of formal education spent in the PRC. This background is an added advantage over many of our competitors in terms of understanding the PRC. I am from an arts stream with special personal interests in history, philosophy, psychology and economic thoughts. This helps me understand the qualitative side and irrational part of investor behaviour. Meanwhile, my other colleagues are from science background, which helped me formulate the quantitative approach in the decision-making process.
What kind of situations does your event-driven fund invest in? What is the typical breakdown of your strategy allocations? How dynamic are these allocations?
We are basically value investors. We tend to spot hidden jewels that may have M&A, privatisation, recovery or re-rating potentials. We are also keenly looking into the upcoming opportunity of a potential merger of A, B and H shares which may result in unlocking hidden values of the price differences amongst the three markets.
In our long/short book, we also formulate certain pair trades between closely related companies that are currently mispriced due to investors' lack of appetite for holding parents. We may initially build a small position in an (event-driven) idea, constantly review our positions and check if our original ideas are still valid, and if we become more confident we will top up our existing positions, or vice versa.
What is the typical structure of funds investing in the region in terms of, say, manager location? Why?
Currently, funds investing in the region are mainly located in Hong Kong, but there is also an increasing trend of new investors being based in Shanghai. Managers choose to locate in these two cities mainly for their proximity to the market. Information flow is much faster and travelling time for arranging company visits much shorter.
It is stated in the fund investment mandate that it has a concentrated portfolio of 30-50 stocks. Does this portfolio have a sectoral focus, either generally or specific to recent market events? If yes, what is the usual breakdown of asset allocations by sector, and the rationale behind the same?
That we tend to have a concentrated portfolio does not mean that we give up diversification. As a principle, we normally do not invest more than 30% of our fund's portfolio in a single sector. In mid-October, our top five sectors are transportation and infrastructure (23%), banking and finance (18%), property and construction (18%), industrial manufacturing (17%), and telecom and technology (17%). This essentially shows our sector preference.
What practices does the fund have in place to manage risk?
For our long book, first we have a preference towards value stocks trading at a huge discount to their NAVs while paying excellent dividends. In the event that share price does not perform, we still have lucrative dividend income to sustain the fund's performance. Second, we have a 10% limit on any single position. Third, we constantly review the validity of every position, and if there are better alternatives, we may switch out of poor performers.
For our short book, with the knowledge that the downside could be unlimited, we have a 20% cut-loss point, no matter how confident we are of such ideas.
And lastly, what is your short-term outlook for the Chinese markets in general, and for investment avenues for hedge funds in particular?
We believe that short-term outlook of the A, B and H share markets remain positive, but we are getting a bit cautious on the valuations of financial and retail sectors in the PRC market. Hong Kong's local plays may continue to be boring, but we did spot a number of undervalued retail operators with PRC exposure that may become tomorrow's stars. In Taiwan, while investors are still very cautious with the never-ending political scandals dogging the market, we are actually getting increasingly excited about the longer term performance.