Why China’s optionality value is investment opportunity

Chief investment officer reflects on recent trip to country and why growth rates there are “hardly a tragedy”

Why China’s optionality value is investment opportunity

Believe the hysteria and the growth slowdown in China will precipitate a global meltdown plunging the developed world into a crippling recession.

Scaremongering? Almost certainly, but there is no escaping the doom-and-gloom China narrative right now. Its economy is undoubtedly slowing down but is it as bad as reported and how much is the stand-off with President Donald Trump influencing what’s being said and written?

Those at Penderfund pride themselves on finding companies with a value edge “under rocks or behind clouds”, as chief investment officer and portfolio manager Felix Narhi puts it.

To get a better feel of what is happening in the People’s Republic, he went there in person to get an idea of the nuances behind the companies.

He told WP: “Often, it’s less about information gathering and more about getting a sense of what’s happening in that economy. You can watch developments from offshore and not really have a feeling about what’s going on. And on the ground, it’s quite different.

“It’s not really that we’re going over there to differentiate stocks that anybody else can’t get, it’s building that conviction that things aren’t falling apart over there, that’s for sure! Despite the hysteria narrative that you hear over here, things are slowing down but the growth rates they are talking about are hardly a tragedy.”

While it’s no revelation that the Chinese economy is hitting the brakes, Narhi said the crucial question is how much of it is priced in? He added that much of it has been discounted in stocks, but by too much or not enough?

It’s an equation that is top of mind when he’s looking for companies that, like Amazon in North America, have continued to make headway in tougher economic conditions. Narhi likes Baidu and JD.com, which Penderfund holds, and they align to some key points that, statistically, increase the chances of success when picking secular growth stories.

Narhi said: “One of them that is a common theme across our holdings is that they have to be founder-led. There are plenty of studies on this but in the long term, founder-run companies tend, on aggregate, to significantly outperform non-founder companies. Even if you look at the FAANGS today, except for Apple because Steve Jobs passed away, they are essentially founder-run companies and still are.”

Look across the water and many of the large Chinese companies are also led by their originators, while they also have a huge user base, which can be leveraged when you introduce new lines of businesses.

This optionality value, while hard to quantify, is what makes many Chinese companies so attractive. Throw in the fact slowdown could cheapen stocks and the Far East financial behemoth becomes a more alluring place to invest.

Narhi explained: “You pay a decent, OK price for the existing business and you get all these things you may be talking about five years from now … things that are driving the businesses of the future. We like that stuff.”

One mantra around the Penderfund office is that companies come in two buckets: those that have problems and those that are going to have problems. Finding the ones that are mispriced is the key to unlocking value.

Narhi draws parallels from China now to North America in 2008-09 when there were a lot of doubts in the US economy and no one wanted to invest.

He said: “There are a lot of clouds in China but there were a lot of clouds in North America in 2008-09 and that was not the time to be worried about the clouds because the sun came out – and the sun will come out again for China at some point.”

He added: “In many ways they are ahead of us; they have adopted technology quicker because they don’t have legacy infrastructure. There’s this narrative that China is a copycat but that’s just not true in many areas.

“If you go over there and see what’s happening right now, increasingly the Western giants are looking to China to see if they can copy them. They are out-innovating the US and if you can get access to these companies when there are some clouds and people don’t see this optionality and are more focused on North American companies, I just think that is very interesting.”

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