Chinese equities, particularly the A-share market, surged in 2014, driven by the government's policy easing moves and the launch of the Stock Connect progamme. The rally in A-shares played a significant role in boosting returns of many funds in 2014.
With this as the backdrop, this week’s Head-to-Head puts the GAM Star China Fund and the PineBridge China A-Share Fund against each other.
Both funds are domiciled in Ireland, but their investment focus differs.
The GAM fund focuses on investing in companies with significant business activities in the People’s Republic of China) and Hong Kong and invests primarily in China H-shares (Mainland companies listed in Hong Kong).
The PineBridge fund, on the other hand, invests primarily in A-shares (Chinese companies listed on domestic markets) using its qualified foreign institutional investor quota.
The GAM fund is comparatively larger in size and also has a longer track record.
The GAM fund was launched in July 2007 and had $2.2bn in assets under management on 31 December. The PineBridge was incepted in October 2011 and had $224m in AUM, as per Bloomberg data on 6 February.
The Mainland market has always been prone to volatility. Hong Kong's Securities and Futures Commission recent report also said that volatility has emerged as a key risk in Chinese markets, with the Shanghai Composite Index soaring by roughly 53% in 2014.
As China gears up for further policy easing moves and capital market reforms, which of the two funds, essentially representing A-shares vs H-shares, has the potential for the best performance?
“One could argue that a comparison of the two funds should not be done, given their different focus.
“However, it is critical for investors to note that many different funds are all simply labelled as ‘China equities’, and it is important to do one’s due diligence before investing to fully understand which part of China equities are being targeted,” said Leonardo Drago, chief investment officer at Al Wealth Partners, who provided a comparative analysis.
Investment strategy review
The GAM fund had about 87.5% of its assets invested in China H-shares and 12.43% in Hong Kong shares on 31 December.
The vehicle has concentrated its investments in large-cap companies listed in Hong Kong.
Financial companies dominated the fund’s portfolio with a 36% weighting. Information technology and consumer discretionary companies had 28.2% and 14.7% allocation in the portfolio, respectively.
Turning to PineBridge, Drago cited data from the fund’s annual report for 2014, which reflects holdings on 30 June 2014 (a more recent fund factsheet was not available).
Drago said the fund has invested more than half of its capital in financial companies such as banks and brokerages and about 7% in energy-related companies.
“The PineBridge fund [by comparison] has built up positions in onshore Chinese companies that make it a better proxy for the onshore Chinese stock market performance, with stocks like Kweichow Moutai [one of China’s best known liquor brands].”
Performance review
The GAM Star China fund and the PineBridge GS China fund showed a similar performance record in 2011 with 9.36% and 10.30% annualised returns respectively, noted Drago.
GAM Star China has been on radar of many investors in the last few years, Drago highlighted.
“The GAM fund’s breakout year came in 2013, when it registered a gain of 27% against the HSCEI’s [Hang Seng China Enterprise Index], which fell 1.3% and the Shanghai Composite index, which declined by 3.8%.
“This strong outperformance was primarily due to the funds’ positioning in the Macau gaming companies and stocks like Tencent, all of which strongly outperformed in 2013.”
Although the sector allocations proved positive for the GAM Star China fund in 2013, they had an opposite effect in 2014.
“Following a China government crackdown, Macau gaming was negatively affected, with the stocks falling by as much as half of their value during the year. As a result, the GAM Star China fund posted a negative return of 5.4% for 2014.”
The PineBridge fund, by comparison, tracks the Shanghai Composite Index closely, which was one of the worst performing stock markets from 2010 to 2013, Drago said.
The market decline reversed in mid-2014, as the Chinese government started taking policy-easing measures to counter the country’s slowing economic growth.
“The Shanghai Composite gained 60% in the second half of 2014. In the same period, the PineBridge fund gained 73.4%.
“As these two funds show, performance results can be widely divergent, and investors who focus on the best performers only over the last year may well end up with a sub-optimal China allocation for the coming year.”
Scenarios for fund outperformance/underperformance
According to Drago, the valuations of current holdings in the funds, as well as the respective sector allocations, would be a way to understand how the vehicles will perform in the near term.
The Macau gaming stocks that had a sharp fall in 2014 are now trading at attractive valuations, and this might favor the GAM fund, he said.
Also notable is the divergence in the performance of A- and H-shares.
“PetroChina–H, listed in Hong Kong, fell 20% from its peak in August as would be expected from weakening oil prices. However, in the same period PetroChina–A listed in China gained 40%.”
He cited similar divergences in the banking sector. The Agricultural Bank of China–H gained 9.51% in 2014, whereas the Agricultural Bank of China–A gained 60% in the same period.
These differences play a significant part in the funds’ performance.
"So, it is not sufficient to compare a fund’s performance against the Shanghai Composite and then conclude that the manager has not done a good job if the fund has underperformed.”
Manager review
According to FE Analytics, Michael Lai has been managing the GAM fund since its inception in July 2007. He is the investment director responsible for GAM's Asian funds, and is a co-manager of GAM's Pacific funds with Ben Williams.
PineBridge did not name the lead portfolio manager.
Fees
The GAM fund levies management fees of 1.35%. The PineBridge fund charges management fees of up to 1.75% on Class A units and up to 1.60% on Class Y units.
The ongoing charges or the total expense ratio for the GAM fund is 1.56%, whereas the same for the PineBridge fund is 0.75%.
Conclusion
Drago said the different investment focus (onshore versus offshore via Hong Kong) has led to a significant deviation in the performances of the funds.
“From a value investors’ viewpoint, the divergence in stocks of the same company when comparing A- versus H-shares means that we would favor investments via H-shares, which are far more attractively valued.”
A few managers have also echoed similar views and said China's H-share market has become attractive compared to premium-priced A-shares.
“The run-up in many onshore China stocks has strong momentum behind it, but is unlikely to be sustained over the long term.
“Finally, we also find the valuations of Macau gaming stocks attractive, as the market is pricing in significantly lower growth in perpetuity. So, any change in the Chinese government crackdown in the near future would be a strong positive for the sector.
“Taken all together, at current valuations we would favor GAM Star China.”
