Interview with Xie Xuefeng of Value Star Asset Management
Value Star is an asset management company focusing on investments based in the Greater China region, with its research team based in Beijing. Value Star runs a long/short strategy focusing on Greater China, with an AuM of US$20 million.
As an equity long/short fund focusing on value-investing, what investment process does it employ? Could you go through a typical transaction of the fund that will help illustrate your investment process?
We analyse financial market dynamics and the Chinese macro economy, look for the intrinsic driving factors, from top-down to select industries and allocate our assets. Before we invest, we go through the financial review, valuation model and due diligence process by company visits. We combine top-down with a bottom-up stock-picking approach.
Take Guangzhou Shipyard Int’l as an example. At the end of 2005, we believed the international shipyard building industry was shifting to China, just like it had happened in Japan and South Korea before. Comparing listed companies in this industry in China, Guangzhou Shipyard had a healthy financial status and good management. 2004’s financial results did not look good because the material cost increased substantially. However we believed that the ship delivery prices for orders placed many years ago would certainly be adjusted after we met the management team and buyers. Guangzhou Shipyard had posted more than 100% profit increase for the past two years. We had visited the company three times, and added it to our portfolio at a price below $3 per share. The share price surged to above $25 in 15 months.
What is the average holding period on your investments and the turnover of the portfolio? How evenly is your exposure distributed between shorts and longs?
The holding period depends on how fast the stock price moves. Normally, we plan to buy and hold for at least one year. However, if the price increases sharply or reaches our target, we will consider selling.
Turnover of the portfolio is quite low, on average less than 25% per quarter. It was around 140% last year.
On average, long/short exposure is 80/20.
What is a typical breakdown of the sector exposure of the fund’s portfolio? Do you foresee any significant shift in this breakdown in the near term? Why or why not?
We prefer to allocate 25% of long exposure to each of the following four big sectors: consumer; financial service; manufacturing (with higher entry barrier); and IT and real estate. This breakdown doesn’t consider short positions.
We do not foresee any significant change in this breakdown in the near term. Consumer should not be affected much by macro policy changes at this point. The financial services environment is improving.
Manufacturing companies we pick all have strong competitive advantages and should not be affected by cyclical events. Meanwhile, as a general rule, we would not invest in an industry that we don’t have our edge in. For example, while commodity prices have increased a lot, we still try to avoid those cyclical companies strongly affected by commodity prices.
Moving on to performance, how has the sell-off in Chinese equities towards end-February affected your fund? Has your strategy taken on a short-bias as a result?
The sell-off in Chinese equities towards end-February did not really affect our fund too much. As mentioned, we avoid holding volatile and expensive stocks and our value investing philosophy provided down-side protection during the end-February sell-off.
Our strategy did not really take on a short-bias. Sometimes short positions contribute significantly to our performance, especially in the last month. However, our stock-picking contributed more.
On a related note, what are some of the key risk management practices that the fund has in place? How have they helped in afore-mentioned situation?
We monitor the market liquidity carefully and use various financial tools to hedge the market volatility. Being part of the emerging markets, Chinese stock markets tend to be volatile. Even though we pick the right stock, the market risk is still high. Therefore, we also adopt some mandated measures such as exposure limits, position limits and stop-loss policy.
China-focused long/short funds have had a terrific run in 2006 (the Eurekahedge Greater China Long/Short Equities Hedge Fund Index was up 57.5% for 2006). Your own fund has returned a comparable 50% during the same period. What portion of this performance would you attribute to bullish markets and what portion to your brand of value-based investing?
First of all, our average net exposure was quite low, which did not reach 60% in 2006. The correlation between our portfolio and index was around 0.4, also very low. Our portfolio’s P/E ratio did not change significantly in the past year. I think most of the performance was contributed from value-based investment, not from liquidity driving. The companies we invested in all had significantly increased their earnings and their future growth prospects look bright.
Recent Eurekahedge research on hedge funds allocating to Greater China showed that while the year 2006 saw most of the hedge fund asset flows into the region going into equity long/short strategies, arbitrage and event-driven strategies were the better performers during the same period. What impact, in your opinion, would the impending consolidation of the A, B and H-share classes have on your fund?
Actually, the correlation between A, B and H-shares is not as strong as people thought.
Implementation of QFII has attracted more institutional investors to the A-share market and moves the market closer to international standard. But the A-share market’s valuation is high now and is getting higher because of the bright prospect of Chinese-listed companies and strong domestic liquidity.
H-share market has a closer relationship with the Chinese economy.
Last year the A-share market outperformed others quite a lot. Since we could only manage to obtain a little QFII in December 2006, A-shares did not contribute much to our fund’s performance. A-shares are quite expensive now. The increase in A-share valuation may be a disadvantage for us last year, but with the QDII impending, it should be an advantage for us this year. No matter what happens on the impending consolidation of A, B and H-shares, we will insist on our value approach.
On a broader note, what is your short-term outlook for the fund as well as for the underlying markets in China? Do you foresee more regulated markets, for instance?
For China domestic market, A-shares are more likely liquidity driven and we do not think there will be significant changes in the short term until the supply increases significantly.
H-shares have just experienced a big correction, so they will be stable for a couple of months.
We do not foresee any severe restriction in the market. In China, the regulatory authority prefers to use market-oriented instruments now. We anticipate another interest rate hike in the near future. I think our fund will do well in the coming months. Last three months were a test for us and we believe we can continue to deliver performance for our investors even in a challenging environment.
And lastly, there are currently over 40 equity long/short funds allocating to Greater China. How does your fund differentiate itself from the rest?
First of all, we have an experienced team! I have been with the Chinese equity markets for more than 15 years and have gone through as many cycles as the markets have. Secondly, we have developed a standard investment process which has been tested since I served as the head of proprietary trading department at J&A Securities Ltd. Even though the market has been very volatile in the past ten years, we made money every year. We not only focus on long-term growth but also keep track on short-term volatility. We are trying to provide a balanced product with competitive returns for investors. Thirdly, we have a local research office in Beijing staffed with local people. The investment team has visited most of the companies’ management teams multiple times and knows the companies in and out.