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Some US fund managers say China is taking a shrewd approach by opening its capital markets while maintaining control over ownership of domestic equities. For example, some Chinese companies like the idea of western-style governance but don’t like the West controlling or owning too much stock. ‘They’re very happy for the West to introduce best practice standards, but they’re not happy selling the actual ownership of the industry,’ explains fund manager Mark Edwards from Hong Kong-based T Rowe Price. ‘And they don’t want lots of hot foreign flows they can’t control.’
The need to maintain control isn’t surprising from a country still in the grip of the Communist Party, and now the world’s most dynamic economy. The Chinese government continues to stifle freedom of information and maintain caps on foreign investment in domestic equities. As such, investing in China is still risky with IR a precarious exercise for some issuers.
‘The new regime has taken a big step back in the media sectors,’ says Edwards. ‘They don’t want bad news blasted around by media companies. The previous bunch was happy even to wear Stetson hats at Bush’s ranch, but the new gang is quite different.’
China’s ‘new gang’ is headed by President Hu Jintao, elected by the National People’s Congress in 2003, succeeding his predecessor Jiang Zemin. Jintao, a former engineer – also said to be a mean table tennis player – is thought to be cautious in style. Not an out-and-out reformer, he nevertheless cracked the whip on pro-independence reforms in Tibet in the 1980s. But the Chinese premier is pragmatic enough to allow a trickle of investment from international investors through China’s qualified foreign institutional investor (QFII) scheme, allowing non-Chinese investors to trade restricted amounts of yuan-denominated shares, which was not possible until late 2002.
Tight controls
But what is it about Chinese IR that continues to make some US fund managers circumspect, especially given the relentless hype surrounding Chinese economic growth? Dr Matthew Wu, a fund manager at Rockville, Maryland-based Rydex Investments who grew up in Asia and studied at Shanghai’s Fudan University, says he understands IR’s challenge here.
‘They’re not used to dealing with being asked questions unexpectedly, especially on ownership structures,’ Wu explains. ‘A lot of companies are family or government-owned. They’re not used to talking to the buy side, even if they were to buy all publicly floated shares. But as a fund manger I need to ask Chinese IR about background information. How do I understand your country? How can I quantify the information given in my investment model? This demands that IROs be more knowledgeable about their own country and industry. Very often we ask them something and they can’t answer. They say, This is Hong Kong (or China), and we do things differently. That’s not enough! I need to know the difference between your structures and ours so I can understand my model.’ Wu adds that much of Chinese corporate culture remains rooted in relationships based on personal contact rather than signed contracts. ‘When UK or US people sign a contract with the Chinese, they think everything is guaranteed, but all contracts can be revised,’ he says. ‘If you have a long-term relationship, however, they are more likely to honor those bonds.’
The flip side
Wu’s take on Chinese IR is challenged by Edmund Harriss, fund manager of Milwaukee-based Guinness Atkinson’s $113 mn China & Hong Kong Fund. ‘Money doesn’t have any culture and you can lose it just as quickly in the East as in the West,’ Harriss says. ‘You have to use a standard approach to investing in Chinese equities, not put them in some special place in the investment pantheon. That’s what eleven years of experience has taught me.’
Harriss uses several criteria to assess Chinese equities. Quality is key, as are good cash flow-based returns. ‘We’re seeking information we can use in conjunction with discounted cash flow and earnings momentum,’ he says. ‘Can returns be sustained? What is happening to the cost of materials, transport and energy? Does the company have the ability to generate surprises with new product development?’
Harriss adds that Asian governance is generally improving but progress in this area is now showing some signs of fatigue. ‘The push to improve governance has weakened as Asia has emerged from crisis,’ he notes. ‘Minority shareholders are still often ignored by management – although regulation is proving more supportive so management doesn’t always get its own way.’
Ideally, fund managers want Chinese IROs to be as specific as possible with their answers, avoiding platitudes. ‘Good IROs understand their business and understand what investors are trying to get hold of, and why,’ says Harriss. ‘Too often IROs hide behind ‘competitive reasons’ for non-disclosure. We want to know what the main revenue drivers are, such as price and volume. We want to get a handle on the breakdown of cost of goods. We want an idea of expansion plans, number of production lines and capacity, and we want a view on timing.’
Harriss acknowledges that IROs can’t always provide this information. ‘But questions and answers have to lead us toward these specific issues, otherwise discussion is meaningless,’ he adds.
Edwards notes that state-owned enterprises struggle with determining what information investors need from IR. ‘They’re still learning from a position where they have a lot of data, but they’re not sure sometimes which data people are interested in,’ he says. ‘They’re not being deliberately unhelpful. But they’re still going from a non-profit making organization to something far more focused and getting a return on that investment.’
Edwards notes that younger Chinese entrepreneurs sometimes appear savvier at IR. ‘Some of the younger people are very aggressive,’ he says. ‘That means examining the prospectus is important, as is using good advisers. You need a ‘big four’ accountant that has lots of people digging away. If a Chinese firm is reversing into a Hong Kong-listed shell company, for example, the safeguards are not as good in terms of prospectus requirements.’
Less attractive, too, is the certainty that China’s ruling Communist Party will continue to play an active role in the vetting of appointments at red chip, state-owned companies. This means CEOs and top executives must also be adept politicians.
A mixed bag
Yet, over the long term, there’s no doubt the China dream offers staggering opportunities, even if some of the gains have already been realized. Stephen Dowd, head of non-US equities at Chicago-based Northern Trust Global Investments, has shifted some of his cash out of China to Japan for the time being, where he is betting on the rude health of the Nikkei.
Dowd’s experience of Chinese IR is that he must insist on frankness, especially in an environment where the economy is running hot. ‘Chinese IR is OK but it needs to be a lot better,’ he says. ‘I saw a Chinese IRO recently and she could talk only about the last quarter’s numbers. She couldn’t answer anything about the strategy of the company, or its ideas. Nothing. The depressing thing about this is that companies now are benefiting from a rising business cycle, but not necessarily from their own position in it.’
Several Chinese companies are planning to list on the NYSE in the next year. However, Richard D’Amato, a key member of the US-China Economic and Security Review Commission, recently warned that fundamental lack of transparency remains a worry, as does the amount of bad debt some Chinese banks planning to list might be carrying. D’Amato claims investing in some Chinese companies could lead to a dot.com-style crash.
Overall, IR gets mixed reviews in China. The Chinese old-school oligarchy-based style of business may be holding back IR’s development for many large issuers. Edwards says the exchanges in Shanghai and Hong Kong are working hard to effect change and progress in IR. ‘But too many IROs over-egg the story,’ he cautions. ‘It’s when you go through difficult times that you really build relationships with investors. And it’s at that point that both parties learn what works, and what doesn’t. That hasn’t happened yet.’