• 2019 Second Quarter Review
    July 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 return since inception. More remarkably, the Fund achieved the good performance without adding volatility.

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    Trade War Update
    Since the last quarter, the trade war between China and the US is further mitigated. Although the US raised tariffs on $200bn of Chinese products from 10% to 25%in May, the tension between two countries was cooled at the end of this quarter as the G20 Summit in Osaka Japan concluded. In the second meeting of Xi and Trump, the two countries agreed to restart the negotiation and the new tariffs on Chinese products will not be imposed. As reported by the press, the discussion has mostly focused on the US demands for a system to ensure that China abides by its promises, including purchasing more US produced goods and moving towards a more market-based economy. According to Steven Mnuchin, US Treasury Secretary, “enforcement offices” would be set up in the US and China to monitor the enforcement of the agreement. In spite of multiple rounds of talks and claims of significant progress by the negotiators, the trade deal still has not been finalized and an agreement may not be reached until August or even September at the earliest.

    Continuous Stabilization of Chinese Economy
    Chinese economy grew slowly at 6.2% year-on-year in the 2nd quarter, lower than the 6.4 % reported in the 1st quarter. However, the result was in line with expectations of the National Bureau of Statistics of China, and the performances in June have improved. The manufacturing industry perked up. Comparing to that in May, both industrial production and retail sales growth increased; the domestic consumption has remained robust. On the other hand, the industrial manufacturing activities and consumption sentiment in China have been negatively impacted by decreased export orders, declining property investment growth, tightened monetary liquidity, fear of being isolated by other developed countries, and technology sanctions by the US. As the trade dispute has abated and some measures were taken by the Chinese government, such as tax cuts, real estate regulation, and medium-term lending facility, the Chinese economy has been supplied by additional monetary and fiscal supports. Nevertheless, investors should beware that the Chinese government may pull out some of its stimulus policies if the economic prospect improves after the two governments reach a trade deal.

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

    Kweichow Moutai (600519 SH) the revenue and net profit increased by 18% and 26% respectively in the half year of 2019. The operational performance in in the half year of 2019 was better than its previous 14% revenue growth guidance for full year 2019. The growth of net profit in the 2nd quarter slowed down compare to previous quarter, with two possible reasons: 1) the new sales plan has yet to be kicked off after the elimination of inefficient sales channel in last year; 2) the benefits from value-added tax (VAT) adjustment in China have not fully reflected in recent financial reports. However we believed that the downside of the counter is limited due to healthy cash flows and the strong balance sheet, combined with Moutai’s robust and continuous revenue growth trend. Looking forward the second half, strong demand exceeding supply will drive Moutai’s revenue growth.

    During the preceding 3 months to June 2019, we also added 2 interesting stocks to the portfolio, namely Midea, and Alibaba Group.
    Midea (000333CH) is one of the top leading white goods manufacturing brand in China. The household appliances is main profit contributor, with one-third contribution from online sales and growing. The revenue and net profit in 1Q2019 grew 7.8% yoy and 16.6% yoy respectively. Due to the global economic slowdown, diversified product chains can ensure revenues are not severely affected. At the same time, the traditional businesses laid foundations for the realisation of the IoT technologies. When we initiated the position, the stock was selling at 15x 2019 PE, one standard deviation below historical average, and we believed the valuation was attractive.

    Alibaba Group (BABA US), as China’s top online shopping platform and cloud service provider, generated half of its revenue by e-commerce retail related business. It charges a percentage of revenue from e-commerce transactions over the platform without logistics overhead. In the first quarter of 2019, the group’s total revenue increased 51% yoy including 31% yoy growth of e-commerce retail, achieved better-than-anticipated operational performance. Alibaba has become a world-class leader in an integrated consumer ecosystem, and its growing user base is the fundamental of its success. Alibaba will soon open its door to US firms on Alibaba.com marketplace with a membership fee. The company wants to offer global access to small- and medium-sized businesses with a particular focus on manufactures, wholesales, and distributors. We expect revenue to continue increase in the next 3 years with sustainable organic traffic growth, and we believe the valuation is attractive.

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    Final Words
    Hang Seng Index fluctuated in the 2nd quarter of 2019, but it is still trading at one standard deviation below its 25-year historical average price-to-book valuation level. Global economy is entering a slowdown phase, and most countries’ central banks prefer loosening monetary policies. The US Federal Reserve expects to cut interest rates by the end of this year. Chinese government has also introduced several measures to simulate the Chinese economy. While facing challenges, the Chinese economy is stabilising gradually and the country is moving towards an open financial market. We believed the risk of a Chinese economic recession is relatively low. Owning a portfolio of well-selected businesses that can both withstand the headwinds and gain market share now will bear fruit in the mid to long term as the global economy gains steam again.

    Our CIO, Mr. Michael Liang, was recently interviewed by the cover story of Economic Digest, one of the leading local financial publications, to discuss our fund’s recent outperformance. Mr. Liang pointed out that the portfolio performed well during bull markets, and was particularly strong when the market was weak. At the same time, he emphasized our bottom-up investing approach---focusing on fundamentals like the quality of firms, cash flows, business model, and management team. Click here to read the full article.

    Foundation China Opportunity Fund with strong 10+ years outstanding performance has caught much attention that it deserved. Recently on July 11, we launched Foundation’s first public fund, the version of our China Opportunity Fund, named Foundation China Equity Fund, which domiciled in Hong Kong. The Fund will be actively managed and primarily investing in equities issued by companies that derive a significant portion of revenues or profits from China.

    Research Team, Foundation Asset Management (HK) Limited
    July 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.