China’s Changing

Skeptical of investing in China initially, Joseph Tse changed his mind about five years ago and reflects on the lessons of experience.

“At the margin, things are changing dramatically,” says Tse, manager of Fidelity Far East. “Companies that we’re meeting today are also dramatically different, new IPOs (initial public offerings); the opportunities have grown by leaps and bounds.” Yet, Tse is quick to add, “China is still a big cyclical growth market and there will still be boom and bust.”

Tse, a portfolio manager at Fidelity International Ltd. in Hong Kong, has been the manager of the Fidelity Far East mandate since August 2003. He’s responsible for approximately $1.1 billion in total assets under management.

Under Tse’s tenure, the Morningstar 5-star rated Fidelity Far East is the top five-year performer in the Asia Pacific ex-Japan Equity category with a compound annual return of 2.6% to Feb. 28. Though modest in absolute terms, that compares favourably with the median annualized loss of 2.4%. The different versions of Tse’s mandate are the only funds in their peer group with positive returns over that period.

While Tse’s fund has also performed in the top quartile over the past one year and three years, investors have suffered painful losses of 32.6% over the most recent 12- month period. During that time, Tse’s losses have been about twice as high as those of the cash-heavy Fidelity AsiaStar managed by K.C. Lee, who was the original manager of Fidelity Far East from inception in 1991 until Tse took over.

While Tse is more fully invested than Lee, he shares his predecessor’s bias in favour of large-capitalization stocks. Based on their current holdings, Morningstar’s, Equity Style Box currently classi- fies both funds as large-cap blend. Since early 2008, Tse has been steering his portfolio of up to 100 holdings toward large caps because of what he considers to be their better risk-reward valuations.

From a country perspective, Tse’s geographic weightings fluctuate, depending on the stock-picking opportunities and the evolution of the market. Currently, China and Hong Kong combined make up 40% to 50% of the portfolio, Korea approximately 20% to 25%, Taiwan roughly 10%, and Australia fluctuates from 5% to 10%. Cash typically ranges from zero to 3%, but is currently around 6% to make room for buying opportunities.

Among the portfolio’s top holdings is Samsung Electronics, which Tse said, “over time, fits the bill.” The company is trading at reasonable valuations and is strengthening brand equity and talents, according to Tse. “Samsung is a talent magnet, it’s self-feeding,” he says, “attracting the best graduates of Korea. As a result of gaining strength, the company can pay for the best people and then reinvest in improving their products.”

Over the years, Tse has tended toward thematic plays and is currently positioned for sustainable themes such as alternative energy and the growth of the Internet.

In the Internet area, differing greatly from English-speaking countries where “Google dominates the landscape, in Asia there are local winners,” says Tse. “This is good for me, I don’t have to buy Coca-Cola to play China. And secondly, it’s not that difficult for me to spot the winner—bigger, stronger companies become self feeding.”

Tse says one of the biggest changes that have occurred over the past five years is the significant increase in the number of analysts in offices outside Hong Kong, such as Korea, India and Australia.

Today, the team consists of about a dozen portfolio managers, along with 31 analysts. “Sharing the space with other portfolio managers and a lot of good thinkers is a real plus,” says Tse.

Positioning the portfolio under current market conditions, Tse says he’s a bit more bearish than usual. “Exports falling dramatically is very true, especially in the last few months, when the world basically stopped,” he says. “In the longer term, there are more and more promising companies that are trading at very reasonable valuations by any standard—absolute and relative—worldwide.”

Diana Cawfield is a Toronto-based financial writer.