Khiem Do outlines the factors that underline the performance of Baring's China-focused long short fund, which has delivered strong returns.
HW: What is the background to your fund?
KD: The Baring China Absolute Return Fund is a long/short equity fund, which invests predominantly in Chinese securities listed in China, Hong Kong and Taiwan. A proportion of the fund may also be invested in non-Chinese securities of those companies that derive significant earnings from China. This could include companies with production facilities in China and Chinese companies listed on foreign exchanges.
The primary objective of the fund is to provide superior risk-adjusted performance through the use of both long and short investment strategies. The fund has a target return in excess of 15 per cent p.a. with target volatility of less than 15 per cent. In negative market cycles the manager aims to protect capital.
The fund was launched on 1 July 2004, and is managed by myself, Khiem Do, with the help of Wilfred Sit, Lilian Co and Henry Chan. As at the end of May 2006, the fund had USD 40.2 million in assets (Source: Baring Asset Management).
HW: How and where do you distribute the funds? What is the profile of your current and targeted client base?
KD: Our client base for the Baring China Absolute Return Fund is predominantly funds of hedge funds, although we have seen increased interest from a number of institutional investors and family offices now that the fund has been running for almost two years.
HW: What is the investment process of your funds?
KD: The investment process we use is basically an extension of the investment process we have been using for many years in the Asia Pacific investment team at Barings, and which has proved successful for our long only products in the region.
We assess the prospects for both individual markets in the region and individual companies using a GLCMV framework - growth, liquidity, currency, management quality and valuation, which helps to ensure consistency and links our top-down macroeconomic analysis with the bottom-up assessment of the prospects for individual companies.
Our long positions tend to be in undervalued, undiscovered growth companies, which we believe we have identified early. For the short side of the book we look for themes or individual stocks, which we believe are overvalued on fundamental valuation criteria and which satisfy out technical shorting check-list. In addition, we utilize index shorts when our conviction on market direction is low or when we are actively expecting the market to decline.
HW: How do you generate ideas for your fund?
KD: Idea generation comes from a wide range of sources. Company meetings and fundamental research by the team in Hong Kong are the main sources of ideas, although we also utilize quantitative screening to narrow the universe of investible stocks to a more manageable size and identify valuation outliers. Other ideas come from discussions with our investment colleagues in London, Boston and Tokyo.
HW: What is your approach to managing risk?
KD:We have a pretty strict approach to risk management, with exposure limits at the individual stock and sector level, as well as gross and net. Value at Risk, volatility, liquidity and the daily profit and loss figures for the portfolio are monitored not just by me, but by a separate risk management team each day in London, which reports in to our Chief Investment Officer. In addition, we break down the sources of performance quite exhaustively in a detailed attribution report each month.
HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?
KD: In general, yes, the performance of the China Absolute Return Fund met our budget and expectations. In the first fiscal year to the end of June 2005 (inception date: July 2004), the Fund produced a net return of 6.7%. In its second fiscal year to date (11 month period to 31/5/2006), the Fund earned a net return of 19.7%.
We do not expect our investment style to change over the future.
HW: What opportunities are you looking at right now?
KD: On the long side of the portfolio we have been looking at opportunities amongst companies in the consumer, infrastructure, property, energy, financials and materials sectors in China.
Our feeling is that Taiwan and Korea also offer interesting investment opportunities in technology companies, materials and consumer goods companies, while Australian resources continue to offer interesting China growth plays.
On the short side, themes in the portfolio include utilities, airlines, and overpriced financials, telecoms and technology stocks.
HW: What events do you expect to see in your sector in the year ahead?
KD: In general, we continue to forecast a strong economy with low inflation in China over the coming 3 to 5 year period. As companies have been more cautious in their use of excess cash and their control over costs, we expect that the healthy top line growth will likely continue to translate into rising profits. The challenge for the government is to ensure that the economy does not over-heat, which could then require a phase of monetary and fiscal tightening.
We also expect to see more relaxation of the rules by the Chinese government regarding foreign investors' portfolio investment in China on the one hand, and on the other, local investors' desire to invest in foreign assets and securities.
We also expect the under-valued Chinese Renminbi to gradually rise further against the US.
HW: How will these changes/future events impact on your own portfolio?
KD: We have generally been positioning ourselves for this macro scenario.
HW: What differentiates you from other managers in your sector?
KD: We believe it's our long experience in China and critical mass in assets we have built up in the region. We've been based in the region for almost thirty years and manage in excess of USD 3.5 billion in the Asia Pacific equity markets, excluding Japan (Source: Baring Asset Management, as at 31 March 2006).
We can also point to the strong long-term track record we have delivered investing in Hong Kong and China in the form of our Baring Hong Kong China Fund, which has outperformed the Hang Seng Index by 3.4% on an annualized basis since 1982 now (Source: Baring Asset Management, as at 31 May 2006).
We have a highly experienced, locally based investment team, with twelve investment professionals based in Hong Kong with an average of 12 years' experience and five involved with the management of Hong Kong China markets, also with an average of 12 years' experience.
Finally, we believe our rigorous risk management process, with an independent reporting line for our investment process team straight in to our Chief Investment Officer, is another point of differentiation.
HW: Do you have any plans for similar/other product launches in the near future?
KD: We have no plans for any other China-related hedge fund launches in the near future. However, there are one or two other areas which we are looking at closely at present.
(Khiem Do was interviewed in June 2006