Tiffany Hsiao’s passion for technology developed at a young age after her family moved from Taiwan to Silicon Valley when she was six years old.
At the time, Hsiao’s father worked in the computer industry and was involved in making one of the world’s first laptop computers. “I had a front row seat to global innovation happening right before my eyes,” she says.
Hsiao sought to develop this enthusiasm for technology by completing a master’s degree in information technology, with the aim of becoming a software engineer. But that aspiration never came to pass as a career in fund management soon beckoned.
“I figured investing in [software companies] was a better use of my time,” she says.
Hsiao is lead manager on the Matthews China Small Companies Fund and co-manager on the Small Companies and Innovators funds. She prides herself on the sleuth-like attributes she brings to due diligence when researching small- and medium-cap ideas for the portfolio.
Her first gig in fund management was with Franklin Templeton Investments as a research analyst for technology media and telecoms, going on to manage its Global Communications Fund. She later joined Goldman Sachs Asset Management in Hong Kong after being lured to Asia by a thriving tech scene and its rapidly growing companies.
“Every day I was sitting in my office comparing companies around the world, and Asian companies were beating numbers left, right and centre – by 20 to 30 per cent.”
She spent six years at Goldman Sachs Investment Partners in charge of the Great China portion of the fundamental bottom-up long-short equity strategy. She gained invaluable risk management experience on a hedge fund but felt she was more geared towards long-term investing.
Private investigations
In 2013, Hsiao moved back to San Francisco and joined Matthews Asia, first as a senior equity analyst, then becoming a portfolio manager on three funds.
A big attraction of Matthews Asia for Hsiao is the fact there is no research budget, meaning the options are almost limitless when conducting due diligence on potential portfolio companies.
“If you want to know about anything, you just book a ticket and go,” she says. “If you are an intellectually curious person always looking for the most innovative stuff and the world’s next big thing, it’s a great place. You have that liberty to go out there and really figure these things out. And that’s who I am.”
Hsiao says at one time she went as far as looking into obtaining a private investigator (PI) licence to help the research cause. “I was trying to go through the exam but I found out you don’t need to be a PI to look through a lot of these structures in China whereas in the US you do.”
The team does factory visits and interrogates the plant managers to find out where the equipment comes from, who does the repairs and how frequently the machines are maintained. “Then we backwards calculate to see if the numbers match up,” she says.
Trade shows and conferences within specific industries such as automotive and biotech are also visited regularly, allowing the team to meet the individuals directly involved, such as doctors and researchers.
Hsiao recalls meeting and quizzing UK golf pro Justin Rose on his reason for switching his golf clubs to a different manufacturer Hsiao was researching for the portfolio.
“I had to find out. I was like, ‘Are you bonkers? It took you 19 years to get to global number one and as soon as you get there you switch your golf clubs. Why?’ He said without any fitting he got 10 miles per hour more on the drive on the first hit. That’s technology right there.”
Small-cap companies in China might typically be considered a riskier market, but Hsiao says the country offers a wealth of “innovators” that punch above their weight and are only in the small-cap bracket because they get overlooked by most investors.
“The companies in China are no longer just manufacturers, banks or internet companies. There’s a lot of the new generation of innovation happening,” she says. “The problem is there’s not enough investors that are focused on this theme.
“These companies shouldn’t be so small. If you told people most of the companies in my portfolio were US, the market cap would be multiple times higher.”
The appliance of science
In the Matthews China Small Companies Fund these ‘innovator’ ideas make up a third of the portfolio. The remaining two-thirds is made up of steady compounders related to domestic consumption that Hsiao believes can deliver 10-20% growth a year consistently, regardless of the macro environment.
Hsiao has identified three sectors in the portfolio she believes will be trillion-dollar industries in the next five to 10 years: biotech; software; and semiconductors.
Discussing biotech, she points to the breakthrough in immune oncology in 2014, noting that prevalent cancer types among Asian and Caucasian populations differ.
There are far more cases of stomach and liver cancer in Asia, but drugs manufactured by western companies are more geared towards the prostate and multiple myeloma cancers more prevalent in that part of the world. This creates an opportunity for domestic Chinese drug makers to step in.
“You can’t just depend on imports,” says Hsiao. “Even though you have great companies like Roche and BMS, they work more for the Caucasian population because they are western companies.
“A lot of the Chinese scientists who used to work for Roche and BMS see this opportunity, too. After 2014, it was like a big light bulb went on. A lot of these Chinese nationals thought, ‘I need to go home and fulfil this huge unmet need. I’ve created these molecules before in foreign firms and I know how the mechanism works’.”
Hsiao says the Chinese government is willing to pay for these new cancer treatments because being a one-party regime, it wants people to be happy.
The second theme, software, is critical to enhance labour productivity in China, especially with 40 million small to medium enterprises in China needing to migrate to software in the cloud imminently, says Hsiao.
“Humans are humans. We have 24 hours a day, you can’t just put a few little motors and automate us like you can machinery. Humans need productivity through software and this represents hundreds of billions of dollars of opportunity within China because of the economic transition.”
On semiconductors, Hsiao notes that China still imports 80% of its semiconductor needs, which is a higher percentage than its oil imports.
“Thinking about national security, as a leader of any nation how could you depend on foreign sources for your largest import and something so critical to your economic growth? We’ve always known that China will have to build up its own semiconductor ecosystem in order to be self-sufficient.”
Brains over brawn
In terms of stock selection, Hsiao says Matthews Asia follows a philosophy of seeking companies in industries where “you can win on your brains and not your muscle”. That means companies that do not use their balance sheet to win business but rather rely on their differentiated products and services.
The 50-strong Asia team – 20 of whom focus on China alone – screens for companies with very high return on invested capital, from a universe of more than 4,500 names. To constitute small cap, companies must have a market cap of under $3bn.
“As a private company in China it is hard to get access to capital. The banks will not lend to most small businesses as they have historically only lent to salient enterprises.
“You don’t want to be dependent on monetary and fiscal policy as a small business, you want to be in charge of your own destiny. This means you must have a very strong balance sheet and good cashflows.”
The initial screen brings the universe down to about 400 to 500 companies, on which the team then does bottom-up “private equity-like” due diligence.
“Often there’s no real research about the companies we’ve discovered. There are no foreign reporters that write about them,” Hsiao explains. “We treat them as if they are private companies nobody knows about.”
Ultimately, the goal is to invest in the top 1% of the universe, which equates to 40-50 companies in the portfolio that tick all three boxes: good business; appropriate valuation; and good management.
