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Value Partners' Cheah Cheng Hye: prepare for China's 'big bang'

Value Partners' Cheah Cheng Hye: prepare for China's 'big bang'

To most Asian investors, Cheah Cheng Hye needs no introduction. The 60-year-old chairman and co-chief investment officer of Value Partners Group, the Hong Kong-based boutique with assets of around $10 billion, is one of the most respected money managers in the region.

Frequently compared to legendary American investor Warren Buffett, Cheah says his personal investing idol is, in fact, another investing great: Sir John Templeton.

‘I am personally a big admirer of John Templeton,’ he says. ‘He was a pioneering investor; Templeton discovered Japan when many people thought it wasn’t a safe market in which to invest. He was a very powerful contrarian investor – that’s my kind of guy.’

Bucking the trend has become a signature investment approach for Cheah, a former journalist turned investor. This contrarian streak has helped his flagship Value Partners Classic fund, which invests in Asia Pacific stocks with a focus on Greater China, return an impressive 2,016% since its launch in 1993 to the end of July 2014, against the Hang Seng index’s rise of 702%.

Malaysia-born Cheah began his career as a journalist soon after high school, working on the Asian Wall Street Journal and Far Eastern Economic Review along the way.

In 1989, he switched careers and joined Morgan Grenfell as their investment research head. Four years later, he teamed up with V-Nee Yeh to launch Value Partners in Hong Kong.

With 20 years of asset management experience under his belt Cheah remains contrarian to the core. At a time when many investors are becoming increasingly uneasy about China’s growth prospects, Cheah remains confident that the country will prove its detractors wrong.

Not running with the crowd

That optimism filters through to his outlook for Chinese equities, even though their performance has lagged the region’s counterparts in the first half of 2014.

‘I believe that in the second quarter of this year the Chinese stock market hit the bottom of the current cycle,’ he says. ‘I expect a 15% upside in one year. This is partly based on the fact that valuations have seldom been so low. Even during the 2008 global financial crisis, Chinese stocks did not trade at such valuations.’

Rock-bottom valuations are also making him cautiously optimistic on the banking and property sectors – the most bombed-out areas of China’s equity markets.

‘Some very major banks that are state-owned are trading at one times book value,’ Cheah says. ‘On a price-to-earnings basis, they’re trading at five to six times earnings.’

It’s a similar story with property companies. ‘Large companies are trading at a discount of 50-60% of their estimated net asset values,’ he says.

Cheah says such bargain-basement valuations factor in a crash landing for the Chinese economy. ‘But the economy has not suffered that so far,’ he says.

Feel the fear and do it anyway

It’s not that he’s unconcerned about the problems plaguing China’s financial system and property markets.

‘I am as scared as everyone else,’ Cheah says. ‘But even if you assume the non-performing loan (NPL) level is higher than claimed – 5% instead of 1% – it is already reflected in the price.’

Cheah also points to another consideration: ‘Whatever the true level of NPLs is, it represents money owed by the Chinese to the Chinese. There is little to no foreign debt, so whatever problems exist, they can be restructured and controlled within the system.’

Value Partners has five equity funds that are heavily tilted towards Greater China equities. Four of them have exposure to the banking sector, although the exposure level (3-6%) varies across the funds.

Real estate currently has a relatively high allocation in three of his funds – China Convergence fund, China Mainland Focus fund and the High Dividend Stocks fund – accounting for between 11% and 13% of the portfolios. In the flagship Classic fund, meanwhile, real estate claims a 9% allocation.

The toughest part of investing

As value investors, Cheah says he and his research and analysis team follow the broad principles laid out in Securities Analysis, a classic investment guide written by professors Benjamin Graham and David Dodd. While applying these principles to Asian markets, Cheah and his team also emphasise the human aspect.

He distills his team’s investment philosophy to this: ‘Picking the right businesses run by the right people at the right price.

‘The toughest part is finding the right people. We see a lot of corporate governance issues in many companies, and it is the largest source of our errors.’

Cheah has no qualms acknowledging that occasional mistakes have been made while picking stocks. ‘A third of everything we do, we wish we had never done,’ he says. ‘But when we decide a particular stock is not good, we get rid of it very quickly. There are some bad apples in almost every batch.’

A strong belief in value investing holds steady even in challenging times. While Value Partners’ flagship fund has performed strongly over the long term, it has lagged the benchmark Hang Seng more recently. While the benchmark has gained 24% in the past 36 months, the Classic fund has returned just 4%.

Cheah attributes that underperformance to investors ditching value in favour of growth stocks. ‘The past two years have been a market for growth stocks,’ he says, adding that the Classic fund’s performance was dragged down by holdings in consumer staples, materials and information technology.

More recently, however, the fund has fared better: the Hang Seng is up almost 18% over the past 12 months, while the fund has returned 18.7%.

New policies and reform measures by the Chinese government, receding fears of a ‘hard landing’ for China and a more proactive stance on the portfolio have helped, Cheah says. ‘In the past year, health care, consumer discretionary and financial stocks have been the key contributors to the flagship fund.’

Looking to the future, he believes value stocks will find favour again.

One important criterion in his decision to buy or sell a stock is the probability of a stock generating profit over a three- to five-year period. Once he has made his decision, he’s not swayed by short-term swings in stock prices. ‘I don’t make buy or sell decisions looking at daily news,’ he says. ‘I am not suited to short-term trading; I actually lose money when I do that.’

This aversion to short-term investing can be traced back to a formative moment at the very beginning of his career.

‘I used to be a short-term trader when I first started investing in the 1970s. At the time, I was working as a journalist for the Far Eastern Economic Review.’ Living in Hong Kong, Cheah traded forex contracts in the Chicago market by telephone. ‘I lost all my money, and that was my introduction to trading,’ he jokes.

The turning point came when Cheah came across two books that helped him forge his investment approach: The Money Masters and The New Money Masters by John Train, which describe the techniques used by many of world’s top investors, including George Soros, Peter Lynch and Warren Buffett.

‘After reading those books, I realised I was more suited to medium- and long-term investing based on fundamental analysis,’ he says.

‘I realised they were ordinary people who did extraordinary things,’ Cheah says. ‘They were able to consistently beat the markets by making interesting investments. These books were a real inspiration to me.’

Taking the long-term view

This long-term focus has led Cheah to be more hopeful about China’s future than most other investors. One encouraging development, he says, is the anti-corruption campaign under way in China, which he believes will improve the role of the private sector and free market.

‘The reforms promise to change the quality of growth, squeeze out much of the prevalent corruption and generally improve corporate and political governance in China,’ he says.

Chinese authorities have undertaken an aggressive anti-corruption campaign targeting party officials working at state-owned enterprises as well as in political offices. According to a China Daily report in July, more than 50 senior-level executives at Chinese SOEs have been removed from their posts since the anti-corruption drive began in 2012.

‘There is a widespread perception that in several state-owned enterprises the profits don’t entirely flow to the company’s bottom line – a portion goes to the pockets of middlemen,’ Cheah says. ‘The campaign won’t change the situation overnight, but these incremental changes will eventually result in a big bang effect.’

In the long run, he expects the clean-up to boost shareholder returns as more money flows to companies’ bottom lines.

In the near term, the highly anticipated Hong Kong Shanghai Connect, which will allow foreign investors to invest in the mainland and mainland investors to invest in the territory’s stock market, is likely to give a boost to Chinese equities.

‘While the number of stocks investors can buy or sell in Shanghai and Hong Kong is not very large – the aggregate quota is less than 2% of the market capitalisation of both these markets – the psychological effect will be huge and more important,’ Cheah says.

Another scheme in the pipeline – the mutual fund recognition platform – is also likely to encourage investor interest in Chinese equities. The scheme will allow funds domiciled in Hong Kong to be sold in the mainland and vice versa.

‘Passporting is likely to happen next year, and when it does it will generate another round of excitement and opportunities, especially for the asset management industry in Hong Kong,’ Cheah says.

All these changes, he believes, will eventually lead to a re-rating of Chinese equities.

So, what’s next on the agenda for Cheah? Apart from growing his business, he reveals he would like to write a book. ‘I’m a history fanatic, and there is so much of Asian history that remains to be told,’ he says.

His love for writing stems from his days as a journalist in the 1970s and early ‘80s, when he covered everything from the people’s revolt in the Philippines (1983-86) to the banking crisis in Hong Kong (1983), which finally led to the peg between the territory’s currency and the US dollar.

Until he writes that book, he’ll have to be content with other journalists writing about him.

Cheah’s biggest surprise…

Asked what has surprised him most about China in all his years of investing, Cheah responds ‘equity markets’.

‘The relatively poor performance of Chinese equities has never failed to surprise me,’ he says.

‘China is one of the world’s fastest-growing major economies, yet the gains on the MSCI China are practically zero over the past 21 years. It’s incredibly disappointing. Clearly, there is a disconnect between the country’s economic and market performance.’

The current bout of reforms, he hopes, will go some way towards making China’s markets more normal. ‘I don’t think the government can afford to have the stock markets performing so poorly. The entire process of capital allocation is distorted if equity markets don’t function properly.’

…And his winning themes

Cheah and his team specialise in the contrarian approach. The star manager credits the success of his funds to the fact that at various times, the themes they focused on became big later.

‘We focused on China B Shares when the idea of China becoming the world’s factory was just taking off,’ he says. ‘We were also there when China got all excited about infrastructure in the 1990s. In more recent years, we have become excited about themes related to improving living standards.’

Currently, Cheah’s team is optimistic about health care, and the agriculture sector also looks promising. ‘Feeding a country the size of China is a challenging task,’ he says.

This article originally appeared in the September issue of Citywire Asia magazine

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