The prospects for China and Hong Kong are looking up, according to Gerald Smith, head of Asia-Paci...
The prospects for China and Hong Kong are looking up, according to Gerald Smith, head of Asia-Pacific equities at Baillie Gifford and manager of the £125m Pacific unit trust and the £41m Pacific Horizon investment trust.
That is just as well, considering some three-fifths of the latter's portfolio is invested in the region. He said: "We deliberately try to keep a mainstream, core-markets approach within the fund which means we've tended to have a lot of money in Hong Kong.
"Now we are finding it more difficult to distinguish between Hong Kong and China but that area tends to be where you find more interesting companies to invest in.
"Standards of corporate governance and transparency of accounts are generally better so it is easier to generate good ideas and the environment is fairly stable and friendly to business. Historically that has tended to create a bias in that direction.
"The way we manage Pacific Horizon does not fundamentally differ from the way we manage money generally. We are stock pickers and while we make asset allocation decisions among regions and countries, the information on which that is based is normally generated by meetings with individual companies."
Smith's optimism towards China and Hong Kong is balanced by a more cautious view on South Korea and Taiwan. The two have some things in common, particularly in their industrial structure, in that they both have large semiconductor industries and to some extent depend on the same global electronics cycle, he said. Korean companies tend to be much more commodity-based whereas the Taiwanese side tends to be more specialist application-specific.
Smith added: "Having believed there would still be an extended cycle in various parts of the electronics industry, we have become concerned that that has become the consensus view. The risk is that something comes unstuck, maybe new capacity comes on faster than expected or there is some shortfall in demand. The problem with these industries has always been oversupply rather than lack of demand, particularly where capital expenditure is coming through, and we are starting to see some signs of that picking up."
This suggested to Smith Pacific Horizon should be taking some money off the table, and coincided with the outlook for China looking better.
"It is a difficult market to work out exactly what is going on. We talked about economic statistics but in China they are dreadful. They are very timely, tending to come up with the GDP statistics the day after the year's finished but nobody believes these are accurate.
"However, there does now seem to be sufficient evidence that the market has improved and the key is domestic demand. It is the biggest part of the economy, and an increasingly important factor within that is the consumer. In the past, uncertainty about the future meant the Chinese consumer tended to save a lot and not spend enough, and that has created major problems.
"You have got overcapacity in many industries and that can lead to continuous discounts in prices and deflationary problems which in turn makes people disinclined to spend because things will be cheaper next week."
Gradually the Chinese leadership has managed to instil some confidence that these issues are being addressed, even if they are not being resolved, and that has been enough to get people at the margin to save a bit less and spend a bit more. That in turn has been enough to remove the excess capacity problem within the economy.
Smith said: "Of course, we have had a favourable background in China before. Almost every year there is China fever when everybody rushes in and buys the same stocks and a few months later everything disappoints and falls down again. We are seeing a bit of that at the moment with the B shares which are available to foreigners and listed on the Shanghai and Shenzhen exchanges.
"But the quality of these companies is poor. They're usually part of a state-owned industry being spun off and often in an unattractive business area. For investors this time round there are more Chinese companies, particularly ones quoted in Hong Kong, that are better-run businesses and so offer better exposure to what's going on in the Chinese economy."
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