Platinum's Asia strategy

This week’s fund manager interview is with Dr Joseph Lai, Portfolio Manager at Platinum Asset Management who runs the Platinum Asia Fund.

Platinum Asia’s strategy is accessible through three investment structures, an unlisted unit trust, a listed exchange quoted managed fund (ASX: PAXX) and a listed investment company (ASX: PAI). The management fee and performance fee is the same across all three vehicles at 1.10 per cent per annum and a 15 per cent outperformance fee.

To see the fund’s performance and how it compares to its peers and the industry standard benchmark, click here.

Here's Dr Joseph Lai, Portfolio Manager at Platinum Asset Management to explain his investment process and philosophy in more detail.

Joe, the big talking point in the media around investing in Asia, especially in China, has been the tariffs between the US and China. Now, is this something people investing in Asia should be concerned about?

Yeah, it is an important consideration and it is something that has caused a bit of, I guess, reduction in confidence domestically and amongst the Chinese exporters but there’s a few things to say about that. First of all, the idea of a tariff has been around I guess for 6 to 9 months now so it’s more or less sort of reflected in the price but it’s not as bad as people say. I make a few points. The first is that the Chinese economy is not as export driven as some people or most people think. In fact, if you look at Chinese exports to the US, it’s a small part of the Chinese economy. It’s basically about 4 per cent of the Chinese economy and China is in fact, these days, a very modern complex economy driven largely by things apart from exports such as domestic activities like consumption services and construction, of course.

The second point is that even with the tariffs China is not going to lose out much in terms of exports to the US and the reason is simply that it’s difficult to find alternatives to replace Chinese exports because China has the scale and supply chain inside of the country and the cost efficiency is very high. The likely outcome, even if we assume the tariff continues, is that the US consumers will end up paying higher prices as retailers pass on the tariff increase. It is also likely, I guess, that Chinese exporters will bear some of the impacts of course. Third thing which is rather interesting is that the issue of a tariff appears to be subsiding, it really looks like that President Trump and President Xi of China seem very willing to make a deal and in fact the feedback we are getting on the China side is that the country has more or less agreed to most of the US demand in terms of a stable currency.

We expect a greater respect for intellectual properties and a reduction on subsidies domestically to help domestic industries in China. Of course, all these things can change – Trump can also change his mind – but all these things seem to be going in the right direction.

Right. Basically, more noise than anything else for investors?

Yeah, I suspect, and as a matter of fact it’s pretty much in the price, especially in the Asian markets. 

Now, Joseph, I’ve called a Sydney number here to speak with you so you’re in Australia here in Sydney, so you’re not sitting over there in Hong Kong or Singapore. Do you actually have boots on the ground in these markets that you’re investing in?

Yeah, look, what we’re doing here is quite unique. So, we’ve got an Asia Fund sitting amongst our global sector analysts, and that’s quite unique, because what we can do is actually we can draw on resources and expertise of global sector analysts to help us to look at Asia. It’s quite uncommon for, I guess, any Asia team or Asia funds to have that ability to draw on people in the same office. But for knowledge and advice and agencies, what we do is, we’ve got a team of six people dedicated specifically to look at Asian equity markets. 

We travel to Asia at least twice or three times a year individually and so right now our China team is actually in China right now looking at interesting opportunities. And the thing is, it’s a bit like boot camp, when we go there we basically – before we go we do a lot of prep work, we shortlist the number of companies which may be of interest, and we just hit them up. We go and meet them, maybe five to six companies a day, it depends on traffic of the particular cities. And after 1.5 to 2 weeks we come back and we regroup and again we use the expertise of the people in our team and also the broader global team to help us, I guess, interpret what’s going on in the place.

I think, the fact is, given that information these days is so freely available, the key is actually in the ability to interpret the new answers of information and looking at what we’ve done.  Over the years we’ve got the track record of doing that reasonably successfully and we’ve got a stable team which really, I think, shows that we are able to understand the dynamics of what’s going on there.

One of the main reasons why I asked that question was because I think the average investor here in Australia and maybe around the world would be sitting looking at China and looking at some of those companies with a bit of say scepticism because they have seen, say, documentaries recently like on Netflix, the China Hustle and whatnot, which I’m sure you’re very familiar with.

Yeah.

How important is it to have those boots on the ground and go around to actually kick the tyres?

I think it is important, that’s why we spend so much time travelling, apart from clocking up Frequent Flyer points. It’s actually quite – it takes a bit out of people’s time and their daily lives. But it is important to actually do good diligence work on these companies. However, I do want to make a point that a lot of those companies sort of highlighted – in fact, all of them sort of highlighted – and in fact all of them highlighted by that particular TV show and, in fact, maybe a few others. I mean they are obviously – they are obvious frauds. The fact is, the quality of those companies are so low that we don’t even look at them and so it’s not a surprise that some of them – or in fact, the ones highlighted in the TV show, turn out to be problematic.

The second point is if you watch the show it’s interesting if you notice how these companies actually came to the markets. I mean, all these companies that appear on that show were basically not IPOs, they were backdoor listings with assets injected into a listed vehicle that’s listed in the US and the companies which actually did the backdoor listing or asset injection, they’re questionable companies, and as the show highlighted, they are typically small US investment banks which actually did those deals. I would say probably 100 per cent of the stocks we look at are proper companies – quality companies most of them – most of them are taken to the market or listed on the market by reputable investment banks, audited by reputable auditors, and then we don’t have much history in that regard.

Can you maybe take me through how, when before your team do go over to China, how do they find these couple of dozen companies that they’re going to go over and actually see and visit when they’re there?

Okay, so I guess the point is, the way we invest is that we aim to seek out good companies whose stock is out of favour and so therefore the outcome is we look for companies – good companies – which are attractively valued and hopefully if we’re right in the next 3-5 years these good companies will turn out to be a bigger company than they are today and then the aim of course is to get into these companies before it gets too expensive. With that in mind, that context in mind, what we look for is we do various things to sort of screen out interesting companies. And how do we come up with that? We use a quantitative method, as well as qualitative and quantitative means – stock screening, looking at valuation, looking at stock price moves and to look for things which are cheap and by definition out of favour.

That’s one way. The other way where ideas come about is just qualitative, and that really comes through as a result of the understanding our analysts have on the various industries that they look at. For example, if a global team is looking at Facebook for instance, and then they have developed some expertise there, it is more often than not they would talk to us and go, look, I mean did you have anything like that in China or in India for that matter these days? The guy in the Asian team would then work with the global guy to see whether there’s anything interesting in that area in China given expertise that’s developed by the investment team.

That’s how idea generation comes about. And of course after that we actually don’t leave it there, we actually try to, I guess, do some preliminary work to understand how the businesses work and how the industry works, how the competitors work and what have you so that we know what’s going on and then to shortlist the companies which we want to visit when we get over there. Because we really want to be effective when we go there and when we meet those companies, then we would know exactly what sort of questions we want to ask, we know exactly what are the pain points or the key areas which can, I guess, help in terms of decision-making, whether to add to it, whether to start a position in their company, or whether to reduce our exposure if in fact something not good is happening.

It’s an elaborate process, and it’s a very collaborative process, but the focus is really on good companies trading on attractive valuation because they may be – I guess, people may have overlooked them for whatever reason. 

Just before we finish on China can you maybe walk me through two current stock examples in the portfolio, one that would be viewed as a bit more blue-chip and something that would be a little more under the radar in China.

Right, so there’s actually lots of them but I guess I can talk through one example which I guess I met with and we also recently acquired. It’s actually a company called Momo, a nascent internet company in China. What it is, it’s basically the Tinder of China. It’s almost a monopoly player in terms of the dating scene in China. and when we acquired it, it was on about 11x price/earnings but revenue is growing at about 30-40 per cent year-on-year and they own a number of properties. As we know with the dating apps these days, there’s actually a different dating app for different segments of the population and these guys actually have two and they dominate in those two categories – one of them is already making good money, that’s why it’s on about 12x or 11x [price/earnings] these days – I think  it’s gone up a bit so maybe about 14x now.

The other app which is, I guess, a more white-collar sort of more serious app, which is almost exactly like Tinder. That business is growing revenues by almost 80-90 per cent but it’s not profitable at the moment because it’s ramping up. In due course we believe that that business will also be highly profitable. They’re continuing to grow their users and then they continue to add features to increase the ability to monetise, like just adding a button so that users can get noticed better by their intended audience, and that’s ramping up. So that’s, I guess, a bit of under the radar idea which we think is very interesting. It sold off a lot last year with the sell-down in the markets, it’s listed in the US – so that’s called Momo, that one.

I have seen this company last year when I went over there and also some of the Chinese team people in my team are seeing the company again just to keep a close tap on what’s going on there. That’s one, I guess the more obvious one, and in fact one we have a big decision in Asia fund and also in other funds in the firm actually, are the insurance companies in China. Insurance companies, they’re big, but in China it is very underserved.  People in China are getting wealthier and then they are also underinsured. The problem is, in China, the government continues to want to improve the social safety net in the way of healthcare and education and it is actually quite a lot of progress being made so far already – but it’s still not perfect. 

What happens is that the private sector, like the Chinese insurance companies – and we picked the best two, basically – is stepping in to sell insurance policies to local consumers and what are the good policies that people like to buy. These are basically stuff like critical illnesses or healthcare coverage. As we can imagine, if the healthcare coverage is not perfect and then a wealthy Chinese person – if they develop heart problems or cancer or whatever, they would like to be covered. That’s what these private insurance policies are covering. They’re basically selling like hotcakes in China and some companies are growing the premium by – in January one of the companies we own, they are growing their premium by in excess of 50 per cent YOY and that’s just more people taking up the coverage and perhaps increasing the coverage.

I think it’s very early in terms of the penetration. If you look at penetration of life insurance in Shanghai which is very modern developed Chinese cities if you’ve been there, if you look at Shanghai’s penetration of insurance compared to that of Taipei which is Taiwan or Hong Kong, it’s miniscule. Even in Shanghai, it’s under-penetrated – think about the rest of China.  What we do there is we buy the best players, we buy the best players in those markets because they were available on very cheap valuations in January. We added to them and I think we’ll keep them for a long time actually so that’s, in a way, an obvious one. But I think people are underestimating the extent to which these companies are able to grow in the future.

One last point is last year me and my insurance analyst spent a lot of time in China, about a week talking to many people in insurance business in Hong Kong, in Shanghai, in Beijing, to see what is going on, the dynamics of what’s going on there relative to history and also relative to other parts of the world. It is an amazing industry that is, I think, underappreciated by people despite its obvious big size.

Right, let’s move away from China now, and I noticed in your December quarterly compared to your December quarterly in the previous year, your investment in India had increased. Now, do you think India can have the same growth potential as China?

Yeah, that’s a good question. It is likely that India will grow faster in the next 10 years or five years for two reasons. First of all, China and India are a similar economic size, so the population is roughly the same, about 1.3-1.4 billion people each. But, China’s GDP or national income is about 4.5x bigger than that of India, so given the low base of India and such a high GDP, now that China has it is very likely China will not be growing at anywhere near 10 per cent again whereas India actually has a chance to grow at least nominally in excess of 10 per cent if it gets its act together. It will definitely grow faster but from a much lower base. 

The thing in India is interesting, the thing is it’s often a place where it is not the easiest to do business. There is still a lot of bureaucracy and often there’s a lot of interference, red tape which makes doing business more cumbersome, and I guess that explains why India has been growing slower over the years or is still stuck in the reasonably low-income level versus China when they were actually very similar 30 years ago. The thing that’s working in India is that a lot of reforms have actually happened under the last two governments and there’s about to be elections soon actually. Are those reforms actually paving the way for is actually, I guess, a very good long-term growth story. In the more cyclical sense, or shorter-term, we are seeing good things happening there. The private enterprises, or in fact the whole Indian economy, has been paying back debts. 

Most economies in the last 10 years, despite the GFC, have been adding on debt – the US did it, US is adding debt, Europe is adding debt, China is adding debt, it’s actually very similar in terms of amount of debt out there relative to the income. India has been shrinking their debt, has been paying back the debt. Now, even with the shrinking of the debt the economy was growing at about 6-7 per cent real terms but what we are seeing is interesting because, firstly, in five years the industrial sector in India is borrowing again, they’re adding to debts again. What we expect is, actually, we’ll see an improvement in growth at least in certain segments of the economy with the debt, with them borrowing money and spending the money.

Finally, we are seeing a nascent stage of capital expenditure cycle out of India so this year they probably do okay and the next few years they probably will pick up in terms of growth rates in India and so I don’t know – I can go on to talk about some of the opportunities we are seeing there or…

Yeah, it’d be great to get an example of a company that you’re invested in India right now.

Yeah, sure. India long-term growth is great because of the reforms. The problem we had in the last few years has been the valuation. It’s not a cheap market. If you look at some of the very stuff that people tend to like which are like fast-moving consumer goods companies, like Unilever or Nestle in India, they’ve got a local listing, I’m sure they’re great companies – I know they’re great companies, but they are growing at 10 per cent or 5 per cent YOY and some of them are on about 40x or 50x price/earnings multiples. I like the long-term story but our investment story is not to pay up for such things because those things are hyped up. 

What we found after sieving through literally hundreds of companies in India are some of the more attractively valued companies. What are those? Those are basically the good private sector banks which actually have gone through five years of not growing that much and then dealing with a bit of a bad debt problem. But now the bad debt problem is way behind us, and in fact, we expect some degree of write-back in terms of the things they have written off, that’s actually not as bad as they thought it was. Then what we have now is actually loan growth, credit growth improving. Last year the credit growth was literally 3-4 per cent YOY in India. This year it has picked up to about 14 per cent so it’s a big improvement and then why these private banks are interesting, well it’s because in India you’ve got the very stale state banks. You cannot imagine how stale they are.

What’s happening is that the private banks are literally taking 100 per cent of incremental market share in terms of loan growth. Every rupiah that’s lent out, actually, the private banks are actually taking almost all of it in terms of growing their book at the expense of the state banks. In due course, the Indian financial sector will be dominated by the private banks. It’s almost like buying the Aussie banks 20 years ago when they’re growing in the nascent phase and they become the top four, and then that’s what we’re aiming to achieve here where we buy the top four to five, two or three out of the top five, let’s say, and then hopefully we believe that it will provide us with very interesting nice long-term growth.

Is it a case of in these emerging market countries that you can go out there and buy the highest quality company that you’re looking for and just let the actual growth of the country and region itself take care of the rest?

Yeah, I think that’s right. I tell you what, early in the year quality was on sale, I guess everywhere, including emerging markets. It’s whether someone is agile enough to actually get in and actually get in and actually get in with the really good companies. As you know at the end of last year global markets have been difficult. Emerging markets was also difficult, clearly. What happened was we have been trying to reduce our exposure last year and that freed us up for some room to actually pick up the high-quality growing companies on actually very attractive valuations. Really, looking at our portfolio today, it is a portfolio of quality growth stories on reasonable valuation. They’ve rebounded somewhat, but still in the long term they are still very attractively valued.

That’s one point. The other point is that if one wants to get access to the Asian consumers, Chinese consumers or Indian consumers, it is actually quite difficult to actually get it from anything apart from buying Asian stocks directly because what we are observing is unless someone from the outside has a product that’s particularly attractive or differentiated, and there are some like for Australia there’s the milk and there’s the multivitamins which I guess the locals find it difficult to make and then the consumers find it difficult to buy from a local person or from a local brand. The locals in a lot of cases, the local companies, are winning out because of the immense home ground advantage.

That’s what we aim to, I guess, capture or to provide exposure to and it’s just good companies, attractive valuation particularly with focus on the Asian consumers.

Finally, one last question here, Joseph, is there a region where you think there is a great growth opportunity but the mainstream media and finance media is just missing it at the moment?

I would say that overall in my region, in Asia, it is India I think that people sort of understand and that’s why you’ve got a bit of a crowding in those very expensive consumer names so we don’t touch those. The area which I guess there’s still a lot of scepticism and I think misconceptions quite frankly, is on China.  China is a place which appears on a newspaper almost every day now, usually something good gets commented on the country but usually something negative. I think that’s consistent in a lot of popular narrative, there’s something wrong, but actually when we look at the stuff that people worry about it’s actually very hard to justify a lot of the worries.  That’s not to say the country is perfect, it’s got problems, but actually in terms of debt it’s not that different to US or Europe, and in fact much lower than of Japan and much lower than that of some of the more problematic European countries.

In terms of asset bubbles, actually the regulator has been extremely tight in terms of containing if not popping all through these years that is actually very hard to actually find anything that’s bubbling. The A sharemarket in China has only gone up like 20 per cent in the last 10 years when the economy has gone up about four-fold – you tell me there’s a bubble. I think there’s a lot of misunderstanding there and the good thing is this though, some of the things they say about China is true but then whatever it is of the negativity it is in the price. The thing is, because of that, there’s actually if one can be selective in terms of choosing the good quality private enterprises doing a good job delivering what the local consumers want you can actually get this company on a reasonable valuation. 

They’re not dirt cheap because everyone knows they’re reasonably good companies but they’re actually cheap relative to their growth potential and quality, so that’s what we try to do. We try to look through the noise and understand the nuances of what’s going on. We think the fact is China will continue to plod along, the good companies will actually do well and the place is not going away. It’s actually going to be probably a super power if it’s not already, so that’s interesting to think about given the narrative about it at the moment.

Excellent. Joseph, thank you very much for your time and I think single people sitting at home, if you’re travelling to China you should maybe check out Momo and help out Joseph’s portfolio there as well.

Yes, give it a go and also jump on a high-speed train. It’s quite remarkable what they’ve got there.

Excellent, thank you very much for your time, Joseph.

Thanks very much, Mitchell.

That was Dr Joseph Lai, Portfolio Manager at Platinum Asset Management.