Graham O'Neill's Hong Kong travel diary - part one

13 Nov 2023

Graham O'Neill's Hong Kong travel diary - part one

My arrival in Hong Kong at the start of October coincided with the mid-autumn festival. Unusually, humidity levels and temperatures were more like early September which is always a warning sign of an impending typhoon, and the predicted typhoon did come to fruition the following weekend. Hong Kong only emerged from Covid-19 restrictions in Spring of this year and as a result, many of the trade fairs and corporate events which normally take place outside of the hot and humid summer months have continued to be postponed or transferred elsewhere. Visitor activity at the airport was still quiet with no queues at immigration. The airport express train to the city centre was running but it was a shock to find that there were no luggage trolleys for international visitors at Kowloon Station as the staff maintaining their availability had not been re-employed. 

I took the opportunity to visit the Victoria Peak Garden for the first time - a site housing an alternate residence for the Governor of Hong Kong. This site is the highest point on the island of Hong Kong with an elevation of just over 550 metres and due to the lower levels of humidity and more temperate climate, the area has been home to many high-end properties since the early 19th century. The area around the Peak tram is always crowded but this less visited area of the Peak has some of the best photographic opportunities with views down to Hong Kong central and across the harbour.


FSSA – Japan update

My first meetings were with FSSA at their offices in Exchange Square, part of the First Sentier Group but operating independently, to get a catch up on the Japan fund, which has had a relatively difficulty 2023, from Sophia Li. Yen weakness has seen a pickup in the performance of value orientated businesses, reversing the trend of the pre-Covid-19 decade when high ROE businesses outperformed. The investment process remains focused on quality companies, which are defined as businesses with high ROE, strong balance sheets and free cash flow and what are believed to be sustainable earnings growth prospects whatever the macro-economic conditions. This year in Japan, low price to book companies have benefitted from the reform efforts of the Tokyo Stock Exchange, but the manager believes that this will not be a permanent feature of the market in Japan and that there has been little deterioration to the company fundamentals of stocks held. The extent of Yen weakness has surprised many and in Japan, companies with high FX exposure and economically sensitive businesses have done best. The manager continues to believe that companies held in the portfolio can deliver compound earnings growth of over 15%p.a. for the next three years and that with valuations having pulled back, there is excellent value in the stocks held within the portfolio.


FSSA – China update

I then got an update on the team’s view on China, meeting Qimin Fei, who explained that the macroeconomic environment in China is much different to the West, with no inflation, resulting in falls in property prices and rents, both in Hong Kong and China. The government in China has been long concerned about levels of leverage and had to put restrictions on property developers in the second half of 2020 and this, combined with a zero Covid-19 policy, saw the economy strangled for two years with balance sheet stress on some property businesses and banks. Within the property sector, there were lower levels of new build and lower prices creating fewer jobs. There has also been a negative wealth effect with more than 70% of wealth in China in property. With much of the population in China believing that prices will fall further, there has been a hit to consumption. ‘Premiumisation’ was supporting consumer stocks in China but there is now evidence of downgrading of consumption habits and out-bound Chinese tourism remains down on previous years. In Hong Kong, although visitations are around 70% of 2019 levels, spending remains well below peak years.  There is a trend in China towards lower cost travel and less high-end spending and this has been seen across the board in home appliance, dairy, and consumer businesses.

The government has provided modest aid to the economy through small rate cuts, but not the old Bazooka stimulus policies and investment in infrastructure has been much smaller than in previous downturns. Youth unemployment is high, is no longer officially reported and graduates are living with family members. The government believes that graduates should be prepared to take menial jobs rather than wait for better paid opportunities in the service sector.  The focus of the leadership is to create high value-added jobs in industries of strategic performance to China like electric vehicles, technology, and semiconductor fabrication. Due to capital controls and the strength of the state-owned banks, the property market in China does not have systemic Lehman risks. There are now signs of some levels of stabilisation in the property market in higher tier cities, although it is the lower tier ones where there is the greatest level of over-supply, less likelihood of strong economic growth and new jobs to drive demand. China has seen falling wages in some industries and even local government workers have seen pay cuts which is why consumption remains weak. 

The team at FSSA believe the current economic weakness is cyclical, but that there are some structural issues which will be longer term. Within their portfolios, there is a focus on businesses which are expected to have the potential to grow much faster than the economy and the team believe that the names held can still deliver earnings growth of close to 10% over medium term timeframes. The team manages both Greater China and All China mandates.


Fidelity Asia Fund

The following day I met up with Teera Chanpongsang who has managed the Fidelity Asia Fund for around a decade. The manager has a bias to quality but is also very aware of valuation and does not believe in buying stocks which are priced for perfection. The sharp value rally did lead to a period of underperformance in the first half of 2022 and the early part of 2023, but with the manager retaining confidence in the stocks held, he has stuck with his favoured, well researched names and performance has now improved. Over the longer term, investing within Asia has always favoured managers that have held high quality businesses. Around 30% of the fund is invested in Financials and these are focused on domestic economic growth stories, primarily listed in India, Indonesia, and Hong Kong. India is seeing strong structural economic growth and continues to have low penetration of financial services and a low loan to GDP ratio for the country. 

Indonesia continues to benefit from its economy, moving away from just producing and selling no value-add commodities to looking to do more processing before selling these on and so taking more of the value add in the supply chain. A core holding in Indonesia is BCA which is a very well run and regarded high quality banking franchise.

In Hong Kong, the financial name held is AIA which is a pan-Asian provider of life insurance and related services, now also expanding directly in China - insurance and savings remain an underpenetrated story within Asia.

Semiconductors are now an essential way of life integrated into so many products, rather than just being a pure play on AI. The market will no doubt grow to $1 trillion. More semiconductor processing capability will be needed over the next decade and both TSMC and Samsung Electronics are two highly regarded semiconductor names among consumer discretionary stocks.

In China, Kweichow Moutai, the provider of the highest quality Chinese white spirit Baijiu, has been a strong performer and continues to improve margins by taking over distribution directly from certain channels. 

The Chinese economy has continued to have a stuttering recovery from Covid-19, but India remains the standout macro story in Asia, benefitting from increased levels of FDI, and is a beneficiary of supply chain diversification from China, which will be a long running story.  Teera believes that: ‘Made in India’, will happen in time and consumption, infrastructure, spending, and demographics are positive.

China has disappointed in terms of economic recovery, but Teera believes that the government will in the end do more to boost consumption to avoid social discontent. The government is reliant on delivering higher living standards for the population to ensure that the Communist Party is in power in 100 years’ time and so people need to be content. There is now an easing in regulation of technology companies which have over the past ten years created many jobs in China and this should favour both Tencent and Alibaba. This year in China, the strongest performers have been SOE names, which traditionally have been poor allocators of capital and considered to be low quality and not owned by external foreign investors. Furthermore, some of the better performing stocks have featured on US sanctions lists. This fund has delivered strong returns to investors over most of the past decade and its focus on high quality businesses with strong franchises should continue to deliver strong returns going forward.

Graham O’Neill, Senior Investment Consultant, RSMR


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