Best of The Web: China Hands
Andrew Tanzer,
To Newport, the secret to investing in Asia is knowing what to avoid as much as what to buy.
Relations between the U. S. and China are in a touchy phase. Does that worry Christopher Legallet, chief investment officer of San Francisco-based Newport Pacific Management? No.
"For me, the trend is what's important in China, and the trend is accelerating economic reform, privatization and a move toward a market-oriented economy," he explains. Legallet has watched China since 1982, when he studied Chinese in Tianjin. After graduating from the University of California, Los Angeles in 1983, he returned to China to trade cow hides before relocating to Hong Kong and gravitating into the fund business.
Newport Pacific, founded in 1978 to invest in Asian equities, indeed has a long-term outlook. Annual turnover of Liberty Newport's Greater China Fund and Tiger Fund--both managed by Legallet, 40, and founder Thomas Tuttle, 60--is a remarkably low 15%.
Patience is rewarded: Greater China, which is down 0.4% this year, has a three-year average annual return of 24%, easily besting the Morgan Stanley Capital International China Index by 10%. Tiger, which invests all over Asia except in Japan, is off 11% year-to-date but has an 18% annual performance over three years, outpacing the MSCI AC Far East Free Ex-Japan Index by 11 points.
Like many overseas funds, these aren't cheap. Greater China runs up annual expenses of 2.25% of assets, and Tiger, 1.7%. Worse, they both have upfront sales charges of 5.75%. Too steep for you? You can buy most of Legallet's stocks via American Depositary Receipts (see table, below).
All issues are ADRs except for Li & Fung. Sources: Bloomberg; Thomson Financial/Market Guide; Newport Pacific Management.
Pacific Rim Picks
Newport looks for Asian companies with minimum cyclicality and sustainable earnings. The firm doesn't want anything from troubled nations like Thailand or Indonesia. Most of Newport's picks, shown here, are available as American Depositary Receipts.
Company/country - Business - Recent price - 52-week high - P/E latest12 months
China Mobile/China/Hong Kong - cellular operator - $24.35 - $49.25 - 32.0
DBS Group Holdings/Singapore - financial services - 28.00 - 54.00 - 10.7
Giordano/Hong Kong - apparel retailing - 5.15 - 6.63 - 14.3
Huaneng Power/China/Hong Kong - independent power producer - 20.96 - 26.24 - 9.8
Johnson Electric/Hong Kong - motor manufacturing - 14.50 - 25.13 - 35.4
Li & Fung/Hong Kong - buying agency - 1.71 - 2.25 - 42.8
Sun Hung Kai Properties/Hong Kong - real estate development - 9.20 - 11.10 - 15.9
Taiwan Semiconductor Manufacturing/Taiwan - semiconductors - 14.65 - 26.79 - 16.6
Newport starts the investment vetting process with a rigorous top-down look at countries. It grades nations on attributes such as quality of political and economic leadership, smooth transitions of power, legal infrastructure and liquidity in capital markets.
Such geopolitical realism has steered Legallet completely away from Thailand, Malaysia, Indonesia and the Philippines. "The vested interests between government and business are so intertwined in some of these economies that the fellows who are losing out aren't going to give up without a fight," he says.
He overweights Singapore, which gets high marks for good, clean government and for deregulating the economy and privatizing state assets since the 1997–98 Asian economic crisis. But he underweights South Korea, despite its 10% economic growth rate last year, because of excess borrowing, highly cyclical industries and lack of transparency in the system.
China is more complex. Legallet thinks the sale of shares in state-owned enterprises such as Beijing Cement is an accident waiting to happen. These heavily indebted entities retain bloated labor forces and underfunded pension liabilities.
After sizing up nations, Newport analyzes industries. Legallet looks for the ones with sustainable earnings expansion and minimal cyclicality. And he wants companies in these sectors with returns on equity consistently above 12%, sturdy balance sheets and transparent accounting.
Newport is big on key members of Hong Kong's real estate oligopoly, such as Sun Hung Kai Properties, which have predictable and healthy earnings. Because of rising incomes in the Far East, Legallet also likes financial services, so he holds banks such as DBS, a top player in the financial center of Singapore.
Technology? Legallet prefers the beneficiaries of global outsourcing--but only those with pricing power, a competitive advantage and top management. That's why he owns Taiwan Semiconductor Manufacturing, the world's leading chip foundry. Legallet thinks outsourcing will remain a powerful trend as companies around the world assign fabricating jobs to Asia.
A new theme for Newport--and Asia's economy--is the shift from exporting to serving the consumer and the business markets of China and India. Tuttle says that strong domestic demand will allow China's economy to grow 7% this year, even with no net export expansion. That vast internal market led Newport to load up on China Mobile, which has 50 million cell phone subscribers, and Hong Kong-listed Huaneng Power, China's largest independent power producer.
Legallet and his mentor, Tuttle, know, however, that gold can turn to dross in any economy, but particularly in those as volatile as the ones in Asia. For example, cash-rich Hong Kong Telecom was once a core holding. But then debt-laden Pacific Century CyberWorks bought the telecom giant last year in a highly leveraged deal. Newport dumped all its new shares in PCCW, getting out before the parent's stock collapsed.
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