As gatekeeper of Allianz Dresdner's Little Dragons Fund, Ronald Chan hopes to ride out the turbulence by being selective on Hong Kong and cutting back on China
Ronald Chan, senior fund manager at Allianz Dresdner Asset Management (Adam), likens his job to standing on a rock in the middle of a raging ocean.
'You can see the waves moving, sometimes you can see where the value is, but people are shifting left and right ... it is hard to keep calm,' he says.
'Bull or bear market, you need to have a steady mind. But that can be hard when everyone is telling you the same thing.'
As manager of Adam's Little Dragons Fund - which is available to retail investors - Mr Chan focuses on small and medium caps in Hong Kong, the mainland, Korea, Taiwan and Singapore. He says the fund is after quality companies with a market capitalisation of up to US$1.5 billion (HK$11.7 billion), rather than speculative penny stocks. Up to 30 per cent of the fund can be invested in anything other than small caps, giving Mr Chan a wide mandate.
'I have very much a free hand on picking stocks so I hold both big caps and small caps. But, of course, a big chunk of my holdings is in small caps as it is easier to find value.'
Last year, the fund - which stood at US$98.66 million as of end-March - gained 0.48 per cent, against an 11.05 per cent decline in the benchmark MSCI Far East ex-Japan Index. In the year to end-March, the fund slipped 3 per cent against an 8 per cent drop in the said MSCI index. Over three years, it has lost 50 per cent but is up 7.39 per cent over five years, compared with a 34.44 per cent decline in the MSCI for the same five-year period.
'Last year, the small-cap sector performed pretty well, so my fund has been doing pretty good,' Mr Chan says.
'I may switch some holdings to big-cap stocks. When I bought a lot of small caps, the yield was 7 or 8 per cent. But now the yields have dropped to 3 or 4 per cent. A lot of the big caps are still giving a 6 per cent yield.
'Also, too many people now are looking at small caps - when the pendulum swings to one side, the end may not be too far away.'
Two locally listed stocks Mr Chan has his eye on are Hong Kong Exchanges and Clearing (HKEx) and Hopewell Holdings, which he classifies as midcaps.
HKEx's turnover to market cap ratio is way below the average of the past 10 years, he says. It also has a strong franchise value in a city that relies heavily on the financial industry. In Mr Chan's analysis, HKEx's 6 per cent dividend yield offers downside protection even if, in the worst-case scenario, the market fails to recover and the company loses its listing income while maintaining a fixed-cost base.
Mr Chan calculates that Hopewell's net asset value is much higher than its current share price. He likes its extensive road assets in southern China and the HK$2.38 billion cash Hopewell will receive from the sale of its Indonesian power plant.
Almost 30 per cent of the Little Dragons Fund is invested in Hong Kong, by far the biggest country weighting, but Mr Chan says it is too early to quantify the impact of the atypical pneumonia outbreak. So far, he has no plans to cut his holdings.
'It really depends on how fast we can overcome this one. Otherwise, there will definitely be an impact on all walks of life and industry,' he says.
He is, however, reducing his holdings in mainland companies from the current portfolio weighting of 8 per cent. This is due to potential overheating rather than any immediate impact from the severe acute respiratory syndrome (Sars) outbreak.
'People are now arguing that the export sector may not be as affected [by Sars] as the domestic sector. In China, a lot of top companies manufacture for export to the US and Europe.
'The density of people [on the mainland] is very high; people work very closely together. If one has Sars, it will affect those around them. But the risk is very hard to quantify. It is more systemic rather than company specific,' he says.
The two factors that have worried Mr Chan are China's first-quarter gross domestic product growth of 9.9 per cent and high fixed asset investment.
He fears that any move to rein in China's economic growth to avoid overheating could hurt the share prices of some mainland companies.
He believes that commodity stocks - not a staple in the fund due to the difficult timing of market cycles - are particularly vulnerable.
Besides mainland enterprises, shares of companies in Australia, Taiwan and South Korea that export steel or petrochemicals to China could also feel the impact. Mr Chan thinks some manufacturing stocks are also starting to look overvalued.
In Singapore, a developed market, Mr Chan says it is harder to find companies that offer the twin benefits of growth and yield.
About 10 per cent of the Little Dragons Fund is invested in Singapore, mostly in high-dividend stocks.
After selling down South Korean holdings since the middle of last year, Mr Chan is starting to see some attractive valuations emerging. The market will remain choppy, but it should pay off in the long run due to a re-rating and the benefits of improved management and lower gearing ratios since the 1997 financial crisis. The South Korean market is trading at about seven times price-earnings (PE), against 14 times in Taiwan and 12 to 15 times in Singapore.
Despite the present troubles, Mr Chan remains positive on Hong Kong companies that are trading at about 11 to 12 times PE. In the long run, mainland proximity will boost growth; and the big caps, which now offer a better risk return than their smaller siblings, are attractive at these levels.
'The stocks may not perform tomorrow. I think it will be easy to make 20 to 30 per cent return in Hong Kong but you may need to wait, even years in some cases,' he says. 'There are a lot of clouds over the economy but at least the valuations are attractive.'
Mr Chan would like to see positive returns this year, but he knows that even careful stock picks can take time to live up to their promise.
For the moment, he would be pleased to offer investors a fund that outperforms the benchmark and gives better yields than bonds To do that, he needs to stick to the logic that his engineering training provides. And he needs a clear head - something weekends away in the New Territories with his wife and son help to achieve.1990: B. Eng in Aeronautical Engineering from Imperial College, University of London
Profile:
1991: MBA from University of London
1992: Joined Barclays Bank as credit analyst
1993: Joined National Mutual Funds Management as investment analyst
1995: Joined Allianz Dresdner Asset Management (formerly Thornton) as fund manager.
1996: Qualified as chartered financial analyst for the Association for Investment Management Research