• 2018 Second Quarter Review
    July 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 and delivered great net returns since inception. More remarkably, the Fund achieved the good performance without adding volatility.

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    Trade War
    June 2018 is the beginning of the trade war between the two largest economies in the world – US and China. After a series of negotiations between the two superpowers in the second quarter of 2018 followed by several announcements from China to lower the import tariffs and make the local market more available to foreign businesses, the US government surprised the world by announcing a series of potential tariffs on Chinese imports. On 6 July, the US government started to impose tariffs on USD 34 billion worth of Chinese products. To countermeasure the US hostility, Chinese government also has imposed tariffs on USD 50 billion of imports from the US. On 10 July, the US government proposed to impose another round of tariffs on USD 200 billion of Chinese imports to be effective in Sept 2018. The negotiations expected to take place between the two governments in the coming 2 months will determine the actual impact of the trade war on the world economy.

    In spite of the fact that the trade war will cause disruptions to many businesses in China, it is also believed that the pressure from the US could force China to open up the economy more drastically. This outcome not only will lead to a better China, but also a healthier long term trading relationship between China and other economies. As a matter of fact, the Chinese government is now busy trying to form tighter relationships with other European and Asian countries, including Japan, by introducing new policies to improve its local business environment for foreign businesses. While the trade war will cause uncertainty to many Chinese businesses, a more opened China is the silver lining of this event.

    ZTE Incident
    On April 17, 2018, the US Department of Commerce filed an export ban on ZTE on the grounds that ZTE did not fully implement the terms of the agreement signed with the US government in 2016. In early 2018, when the US government was investigating ZTE’s compliance of the terms agreed previously, ZTE admitted that it only complied with the agreement partially. Therefore, the US Department of Commerce stipulated that US companies were prohibited from selling any electronic technology or electronic components to ZTE in the next seven years. As ZTE's core business relies on US semiconductor companies such as TI, Altera, Xilinx, etc., it was impossible to find alternative supplies in the short term, and daily operations were severely hit. The company then subsequently announced that it had entered a state of shock. Though the ban was later lifted on July 13, 2018, the incident pointed out the weakness of China – a lack of core competency in high-end technologies.

    Chinese domestic high-end communication chip industry is still in its infancy, and it lags behind the peers in Europe, America, Japan and South Korea by a wide margin. Now, Chinese enterprises are only competitive in low-end products like servers equipment assembly. But for high-end products such as CPU, memory chips, operating systems, data banks and other fields, Chinese companies still do not come close to the US companies. The localization rate of the high-end product in China is only a single digit number. Investors must understand this reality and beware that the fate of many Chinese companies is actually in the hands of their international peers.

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    Holdings Review
    Let’s recap the companies we mentioned in previous issues of quarterly review:
    PC Partner (1263 HK) business performance in 1H2018 was better than expectation. On 16 July, the company announced a profit alert that 1H2018’s net profit was higher than the full year of 2017 due to the very strong sales growth. Also, the company’s proposal to repurchase about 20% of its outstanding shares was approved by the shareholders in late June. As a result of the two positive developments, the stock stays to be cheap, trading at 4.5x 2018 PE with 8.9% dividend yield, though the stock price has nearly doubled in 2018.

    YOFC (6869 HK) business performance in 1H2018 was in-line with expectation. On 2 July, the company announced that the net profit in 1H2018 was expected to grow by 31-45% yoy while the consensus is expecting a 37% yoy increase for the full year. Aside from the spectacular earnings growth, the company also completed the A-share dual listing process. Since the stock currently is still trading at 11x 2018 PE, nearly 20% below its closest peer, Hengtong (600487 SH), listed in Shanghai, we expect the dual listing to help re-rate YOFC further.

    During the preceding 3 months to June 2018, we also added one interesting stock to the portfolio, namely Guangdong Expressway.
    Guangdong Expressway (000429 CH) is a toll road operator based in Guangdong. More than 95% of its revenue comes from toll roads. It now owns rights in 10 roads and they on average will last for 10 years more. While the expiration of operating rights is a concern, the management is totally aware of the issue and plans to spend at most RMB 1 billion capex annually on profitable projects to grow the bottom line. It also partners with different reputable companies including Shenzhen Expressway (548 HK) and NWS Holdings (659 HK) to explore joint venture investment opportunities. After having a conference call with the management, we are confident that the company’s income source will be stable in the foreseeable future and its financials support its promise to pay out at least 70% of its earnings in 2018-2020. We see the stock as attractive because the dividend yield is forecast to be 6% in 2018, comfortably above the peers’ average.

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    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 ago. On the other hand, the trade war between China and US may pose additional uncertainty on certain companies' earnings prospect, it therefore becomes necessary for investors to own a portfolio of well-selected businesses that can both withstand the headwinds and gain market share at the same time. In the past few years, 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 deal with the trade war uncertainty and prosper with the healthier Chinese economy.

    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 three 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 5 billion. 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. Sam Ho joined Foundation as Portfolio Manager and a member of Investment Committee. He is responsible for financial and pharmaceutical sector analysis. He holds a Bachelor of Finance from Hong Kong University. He has over 17 years of investment experience in Asia. He previously was Portfolio Manager at AMP Capital and Senior Investment Analyst at BNP Investment Partners.

    Last but not least, we are pleased and proud to report that we are 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 went 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
    July 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.