• 2018 First Quarter Review
    April 2018

    Dear Investors,

    We are pleased to report to you our investment results and recent developments at our firm and to share our latest thoughts and strategy. We hope you will find it both interesting and informative.

    Foundation China Opportunity Fund is now in its 12th year of history-making performance. This means that the Fund now has more than a decade of solid track record and has delivered 11 full years of great returns to our investors and shareholders. The Fund has outperformed the market. More remarkably, the Fund achieved the good performance without adding volatility.

    MSCI A-Share Inclusion
    In response to the coming inclusion of A-shares into MSCI’s flagship emerging markets index in June 2018, China Securities Regulatory Commission said it would quadruple the daily quota of A-shares that can be bought in Hong Kong and HK-listed shares that can be bought in mainland China. While Shanghai and Shenzhen exchange are two of the biggest exchanges globally, the initial inclusion effectively in June 2018 will only be 0.37% of the MSCI Emerging Index. Further inclusion depends on the A-share market accessibility standards but A-share could become 17% of the Index eventually. This new measure will likely attract more foreign capital to enter the A-share market to help improving its ability to uncover equity intrinsic values and make it more suitable for fundamental investing.

    China President Xi in Boao
    President Xi Jinping recently gave a speech at the Boao Forum emphasizing that China needs reforms and pointing out that opening up the market will help both China and other countries. After President Xi promised foreign companies greater access to Chinese financial and manufacturing sectors, other Chinese officials announced several market liberalization measures including: lowering import tariff on imported vehicles, allowing overseas companies to take majority stakes in financial companies, and opening China’s trust, leasing and car consumer finance industries to foreign investments. These market reform acceleration measures will likely lead to a more efficient China economy and thaw the intense trading relationship between China and the US.

    Holdings Review
    Let’s recap the companies we mentioned in the 2017 September issue of the Fund semi-annual review:
    Hutchison Telecom’s business performance was in-line with expectation but the dividend payout disappointed. We expected the board to declare a special dividend to distribute the proceeds from the sale of fixed line business but it did not. We met with the CFO after the 2017 final results announcement and he said the proceeds could be either paid out to shareholders or used for acquiring other telecom related businesses. Though it is hard for us to predict when the management will realize the value of the cash proceeds, we believe the stock price downside is limited due to the healthy cash flow generations and solid balance sheet.

    During the preceding 3 months to March 2018, we also added a few interesting stocks to the portfolio, namely China Resources Beer and PC Partner.
    China Resources Beer is the largest beer company by volume in China. Its performance in 2017 was better than expected as its core earnings recorded good growth even when the cost inflation posed serious margin pressure to most fast moving consumer goods companies. Chinese beer industry has long been in a cut-throat competition and the last time when the industry raised the beer price was 2008. Beer is even cheaper than water in China! Though the Chinese beer industry is controlled by a few brands, the intense competition still forced brands to earn mediocre margins. But we are seeing changes. Thanks to multiple secular factors including the oligopolies market structure, consumption upgrade, and raw material costs inflation, the market leaders seem to come to the realization that their only future is to stop competing on volume or price but rather on branding and quality. They have been closing down inefficient capacities, increasing price collectively, and most importantly upgrading their product offerings. China Resources Beer, as the market leader, has every chance to improve its profitability from this industry dynamic change. We believe the disciplined market competition and product upgrade will bring its net profit margin, 4.8% in 2017, to international peers’ (AB InBev, Heineken, Carlsberg) level, 10.5% on average in 2017, in the coming 3-5 years.

    PC Partner is a manufacturer of graphics cards, motherboards and computers. The group provides one-stop electronic manufacturing services to reputable brands, namely AMD, and other PC related components and products under its own brand name ZOTAC, Inno3D and Manli brands. PC Partner’s main business (84% of 2017 revenue) is graphics card manufacturing. The company purchases GPU (graphics processing unit) chipsets from NVidia and assembles them with up to another 1000 components before branding and selling it. Due to the strong demand for graphic cards driven by e-sports gaming and cryptocurrency mining, PC Partner’s net profit grew 120% in 2017 and is expected to grow by 30% in 2018. The stock is cheap and currently selling at 5-6x 2018 PE with about 7% dividend yield.

    Final Words
    After the strong performance in 2017, the Hang Seng Index is still trading much below its 25-year historical average price-to-book valuation. We think that after years of economy restructuring engineered by the Chinese government, China’s growth quality has become much healthier than it was a few years before. On the other hand, despite the noise from US President Trump on the trade war, the globe is at the stage of synchronized recovery that could last for a few years. Also, certain Chinese companies were able to utilize the opportunity during the brief economy slowdown to make themselves more efficient and competitive. Now these companies are fully equipped to prosper in this favorable environment. Mark Twain once said, “History doesn’t repeat itself, but it rhymes.” Past experiences suggest a recovery cycle like this one should last for at least a few years and the market valuation could further expand. If this turns out to be case, value investors like ourselves who invest in quality businesses will benefit from the global economy growth and valuation expansion tailwinds. We are excited by the opportunities.
    We have seen an increase in investor inquiries into our China Strategy from both Chinese and US / European investors, our experience tells us that it may lead to a more sustained rerating of China markets, hence even better fund performance for the next couple of years.

    We are glad to report to you that two experienced members have joined our investment team. Ms. Yanming Guo joined Foundation as Deputy CIO, a member of Investment Committee and Risk Management Committee. She has over 16 years of financial industry experience (of which 5 years of Wall Street experience at Bear Stearns & Co Inc.). She previously was Deputy CEO and Head of Fixed Income at CSOP Asset Management with AUM USD 5billion. She has an MBA from Columbia Business School, and is also a CFA. Mike Chan joined Foundation as Analyst. He is responsible for consumers, industrial and real estate sector analysis. He holds a Bachelor of Finance (BBA) from City University of Hong Kong. He started his career as a research analyst at VL Asset Management. He has many years of investment experience in Greater China equities.

    Last but not least, we are pleased and proud to report that we have launched a QDII product by partnering with China Credit Trust Co. Ltd targeting at mainland Chinese investors. We are also working with Chinese and Hong Kong institutions to launch a Hong Kong domiciled authorized version of our China fund as its strong 10+ years outstanding performance have caught much attention that it deserves.
    We thank you for your continuous support. Our team has considerably expanded because of growing investor demand, rising AUM and product line-ups. We are running out of space… To accommodate such expansion (although at a measured pace), we moved to a larger premises on 1st April, 2018. We are all very excited and hope you will have a chance to visit us in the near future at following address: Suite 2703 Tower One, Lippo Centre, 89 Queensway, Hong Kong.

    Yours faithfully,

    Research Team, Foundation Asset Management (HK) Limited
    April 2018 in Hong Kong


  • Disclaimer

    The views expressed are the views of Foundation Asset Management (HK) Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Investors should note that investment involves risk. The price of units may go down as well as up and past performance is not indicative of future results. Investors should read the explanatory memorandum for details and risk factors in particular those associated with investment in emerging markets. This commentary has not been reviewed by the Securities and Futures Commission.