Prescient launches its China Balanced Fund

Prescient Investment Management has announced the launch of the Prescient China Balanced Fund, which has been approved by the Financial Services Board (FSB) to be marketed to the retail market in South Africa. The fund launch comes shortly after the inves

In order to invest directly into Chinese markets direct investments can only be made through a Qualified Institutional Investor (QFII) license holder. According to Liang Du, the Prescient China Balanced Fund manager, Prescient Investment Management was the first African Institution to be awarded a QFII Fund license in 2012. “This allows us to invest directly on the Shanghai and Shenzhen stock exchanges in China, as well as access to the inter-bank market and use of the futures market,” he explains.

The Fund is a sub-fund of Prescient Global Funds plc, an open-ended umbrella fund with segregated liability between its funds and authorized by the Central Bank of Ireland as a UCITS fund pursuant to the UCITS Regulations.

“Investors will have access to the Prescient China Balanced Fund by subscribing to shares directly in Ireland through the utilization of their offshore exchange control allowance, or by investing via the rand-denominated Prescient China Feeder Fund in South Africa,” says Du.

Du echoes market sentiment when he says that China is currently well placed to deliver real returns at a low risk of capital loss for the South African investor, with the added advantage of low correlation with global markets. “We saw the opportunity to offer the South African investor access to the Chinese market through the Fund, due to current investment prospects in the country based on a growth market at decade low valuations. This comes down to supportive long-term policies, encouraging short-term data and an ideal source of diversification.”

The Prescient China Balanced Fund marks a first in Africa to make use of this license. Prescient raised $50m as the first tranche into China and the money was invested on Tuesday 26 March.

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Awakening the Dragon – Investing in the Chinese market

China is currently well placed to deliver real returns over the long term for the South African investor, with the added advantage of low correlation with global markets. This is according to Liang Du, a portfolio manager at Prescient Investment Management, who has outlined the current investment opportunities in China based on a growth market at decade low valuations; supportive long-term policies; encouraging short-term data; and an ideal source of diversification.

Flow of assets

Today China is the second largest economy in the world after the US, and is expected to take the lead by the middle of the 21st century. With a workforce of over 750 million and growth averaging above 10 percent over the last three decades, one would imagine that Mainland China would play a large role in global investments, yet it remains one of the most underrepresented areas in investor portfolios.

One of the reasons behind this anomaly comes down to historical capital controls. In order to keep the renminbi (RMB) in a managed float to the US dollar (USD) and control inflation in China, the Chinese government needed to impose strict capital controls that banned foreign money flow into their capital accounts. This was specifically relevant for Chinese Equity and Bond markets.

In contrast to Japan and the US where the equity market is 26 and 25 percent foreign-owned respectively, foreigners own less than one percent of the Chinese market. Recent policies in China, including the creation of the offshore RMB, the establishment of multiple bilateral currency treaties, the widening of the RMB trading band as well as the relaxation of QFII regulation, all point to the desire to internationalise the RMB as a viable global currency. The implications of this are that foreign flows are likely to increase over the long term, especially into the equity markets.

Valuation opportunities

The above said, over the past five years foreigners have not really missed opportunities in the Chinese market. Its stock market fell into a bear market from 2007, when the world was buzzing about the great modernisation of China. At the time its economy was already growing at a breakneck pace above 12 percent and the Chinese stock market was roaring, with PE ratios of 45 when the rest of the world was at around 15. The invincibility of the Chinese market was priced in as having 10 percent faster growth than the rest of the world for the next 15 years.

The chart below shows the relative performance in USD of the Chinese stock market, which fell dramatically from 2007 becoming one of the weakest share markets in the world following the financial crisis. All this was at a time when we saw strong recovery experienced in both the economy of China as well as company earnings. The result is a market currently trading at decade low valuations, and remaining one of the cheapest markets in the world. Today the share market is pricing Chinese growth at a similar level to the rest of the world.

A sustainable growth path

Another aspect to consider in China is that it is changing its policies by moving away from the massive capital investment based growth model that makes it the export machine it is today. Chinese leadership has realised that the previous model will eventually become unsustainable. At some point China can no longer just be the factory of the world and the new leadership, as well as the updated five-year plan, recognises this and has put China on a new and more sustainable growth path.

To accomplish this goal China is focusing on a number of initiatives. These include policies to decrease corruption, the creation of a new information-based economy, policies that encourage research and innovation, the creation of powerful new industries such as clean energy, strengthening the social welfare system, and ensuring state-owned enterprises are better managed and governed to deliver higher returns for equity holder. At the same time the government will continue to liberalise the market given the understanding that to create wealth more capitalist reforms are required.

Following in Japan’s footsteps

A common question being asked recently is whether China is ‘the next Japan’. In 1951 Japan’s GDP equaled about 25 percent of US GDP, a similar level to China currently. At that point Japan also dedicated most of its focus to fast, investment-driven industrialisation, creating cheap goods, with almost no innovation which they exported to the rest of the world. By 1960 Prime Minister Hayato Ikeda decided that the policy would shift to doubling GDP per capita of people over the next 10 years. It did this by dropping taxes and bolstering welfare (which China is currently considering for lower income groups), raising farm prices and reducing income inequality.

Japan achieved this goal way ahead of schedule some seven years into the plan and continued to surge well into the late eighties. Over the same 20 year period the Japanese stock market rose by over 2400 percent compared to the S&P 500’s 500 percent. China has a very low budget deficit and total and external debt positions, creating a demographic curve that will remain one of the best over the next 25 years. All signs point to a strong dynamic economy with many available shock absorbers.

An uncorrelated market

Investors should not ignore that China represents one of the least correlated markets to South Africa. As an economy it is large enough to have its own business cycle, which differs from the usual US and European cycles. It also has many sectors that are quite different to those of the rest of the world, i.e. a large manufacturing sector versus a large services sector in US and Europe, compared to a large resources and consumption sector in South Africa.

A secondary reason for the low correlation to South Africa is currency. Historically the RMB was tied to the USD and will be for the foreseeable future. This means that China has a developed market currency. In periods of crisis the currency appreciates, making it another source of diversification for South African investors in China.

For Prescient, China represents a great opportunity currently, buying an emerging market with good growth potential and decade low valuations, supportive policies as well as great diversification. China is an opportunity too good to pass up.