• 2018 Fourth Quarter Review
    January 2019

    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 13th year of history-making performance. This means that the Fund now has more than a decade of solid track record and has delivered 12 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 Update
    Since our last quarterly update in October, the trade war between China and US has abated after US and China officials resumed contact. On a working dinner alongside the Argentina G20 meeting in December, President Xi and Trump agreed to refrain from increasing tariffs or imposing new tariffs for 90 days (until March 1, 2019), as the negotiation teams of the two governments work towards a larger trade deal. Almost immediate after the dinner meeting, Chinese government showed its sincerity for cooperation by reducing the tariff rate on US auto imports from 25% to 15% and resuming the purchase of US-soybeans after the suspension in July 2018. In January 2019, the official delegations from China and US held another 3-day face-to-face meeting in Beijing to further resolve trade disputes between the two countries. Chinese officials are expected to visit Washington in the end of January to resume the discussion.

    Asset Price Decline
    After recording minimal asset return volatility in 2017, global asset prices in 2018 experienced the most turbulent year in recent financial market history. The financial market optimism peaked in February 2018 right before the fierce correction of the S&P 500 Index induced by the VIX crisis. The global economy fundamentals started to deteriorate then as the synchronized growth recorded in nearly all major economies was disrupted by the trade disputes originated by the US government. Chinese economy started to show weakness in 2H2018, inaugurated by the automobile sales volume decline that started in July 2018. Then a more hawkish than expected interest rate hike schedule of the Fed has not only generated earthquakes to the emerging markets, but also thunderstorms to the US market. As a result, most assets in the world recorded negative USD returns in 2018.

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    Holdings Review
    Let’s recap the companies we mentioned in previous issues of the Fund quarterly review:

    BOCA (2588 HK) operational performance in 4Q2018 was in-line with expectation. The total number of aircrafts owned by the company increased to 303, up by 9 units compared to 3Q2018. In spite of the engine supply issues, the number of total aircraft deliveries in 2018 amounted to 55, above the guidance given out in 3Q2018 by 3 units. Deliveries guidance in 2019 has been revised upward by 7 units to 79 aircrafts, above the historical high record of 71 deliveries in 2016. The aircraft portfolio looks healthy: average aircraft age stayed young at 3.0 years with 8.3 years average remaining lease terms and aircraft utilization kept at 99.9%.

    During the preceding 3 months to December 2018, we also added 3 interesting stock to the portfolio, namely WH Group, Towngas China, and Kweichow Moutai.

    WH Group (288 HK) is the holding company of Shuanghui Developments in China and Smithfield Foods in US. Both subsidiaries are heavily involved in selling packaged pork products like ham and sausages to consumers, a stable growth business with high margins, and lightly involved in the pork production business, a cyclical business that does well only when pork price is stable. The stock price started to decline in May 2018 as the trade dispute of China-US and Mexico-US escalated. Both China and Mexico slapped meaningful tariffs on imported pork from US and that caused some volatility to the pork price. Smithfield’s pork production business was harmed by the development in 2018. But we believe the market has over-reacted because 1) WH Group’s profit exposure to that business is small and 2) the pork price is likely to recover once the US pork exporters find a new way to reach the consumers in China and Mexico even if the trade disputes are not resolved. When we initiated the position, the stock was selling at 8x 2019 PE and we believed it was attractive due to its stable business profile.

    Towngas China (1083 HK) is the leading piped natural gas supplier in China. The stock price was punished by the market in 3Q2018 because Chongqing government proposed to cut the gas connection fee in the region. Though Chongqing is only a city in China, the market feared the incident was the prelude of a nationwide enforcement. Since connection fees usually account for half of the gas distribution companies’ gross profits, the whole sector was sold down by investors. After a careful investigation, we came to the conclusion that the concern was overdone. We believe the connection fee business prospect is intact because 1) that highly profitable business is the main incentive for gas distributors to work on further network penetrations, a necessary development if the Chinese government is determined to improve the living environment of China with higher clean energy usage and 2) the company has limited exposures to Chongqing. When we initiated the position, the stock was selling at 10x 2019 PE and we believed it was attractive due to its stable growth business nature.

    Kweichow Moutai (600519 SH) is the most prestige liquor brand in China. It is regarded as the signature of business elites in China and commercial deals cannot be done if there is not a bottle of Moutai on the dinner table. The vintage power behind the brand has made the company one of the most profitable businesses in China. The company has been maintaining its 80-90% GPM for more than a decade and that is a strong proof of its pricing power. In spite of the economic volatilities experienced in the past few years in China, the brand has managed to keep increasing the price. Most importantly, people still cannot get enough of it and it is common for the products to run out of stock from time to time. When we initiated the position, the stock was selling at 17x 2019 PE and we believed it was attractive, given the expectation of mid-teens earnings growth at least for the coming 2 years.

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    Final Words
    Hang Seng Index was weak in 2018 and it is now close to the floor of its 25-year historical average price-to-book valuation band. Though there are still uncertainties evolving due to the lingering trade disputes around the world, the economic slowdown in China, and the interest rate hike in US, we believe the negatives are already partly priced in by the low valuations. On the other hand, after years of economy restructuring engineered by the Chinese government, the Chinese economy has become more resilient than it was a few years ago. We believe the risk of an economic hard landing is relatively low. Owning a portfolio of well-selected businesses that can both withstand the headwinds and gain market share at the same time now will definitely bear fruit in the mid to long term as the global economy gains steam again.
    Our CIO, Mr. Michael Liang, was interviewed by the three local leading financial publications to discuss about recent development of the stock market in September 2018. As usual, Mr. Liang consistently reminded readers that the most important qualities any value investors should have are temperament, rationality, and independent thinking. While the mainstream media has been reporting how bad the economy and stock market are, he advised investors to stay rational and keep investing in superior companies to earn alpha.
    To extend the success of Foundation China Opportunity Fund, we are working with Chinese and Hong Kong institutions to launch a Hong Kong domiciled and SFC authorized version of our China Opportunity Fund, named Foundation China Equity Fund, because its strong 10+ years outstanding performance has caught much attention that it deserves.

    Research Team, Foundation Asset Management (HK) Limited
    January 2019 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.