27 October 2016
Schroders fund manager Toby Hudson prefers conglomerates whose management focuses on return on capital. Photo: HKEJ
Schroders fund manager Toby Hudson prefers conglomerates whose management focuses on return on capital. Photo: HKEJ

Schroders: Investors regain appetite for HK conglomerates

If you think Hong Kong conglomerates are now out of favor, think again.

The city’s big four trading houses — Jardine, Swire, Hutchison and Wharf — used to dominate during the colonial era before investment themes shifted to red chips, internet startups and then to state-owned enterprises.

Now investor appetite for these venerable institutions appears to be back. One reason, as pointed by Schroders Investment Management (HK) fund manager Toby Hudson, is that these companies tend to outperform when the local market is bound in range trading and underperforming most other markets.

“As a Hong Kong portfolio manager today, you do have the luxury of getting exposure in other markets which may be a bit brighter at home,” said Hudson, who joined Schroders’ Hong Kong office 22 years ago. “We want companies to have broader footprint, more opportunities. If you are in just one market, and if the market is not good, you have no way to go.”

The contrarian view of buying diversified businesses, as opposed to buying a single market and a single business, is one key reason why Schroders scooped the Lipper Fund Award for 10-year performance.

In its core portfolio, Schroders holds Hutchison Whampoa, Jardine Matheson and AIA.

“We like conglomerates to think like us. They know how to allocate resources to business with potential, and buy back their own shares,” said Hobson, who likes conglomerates with an underlying franchise whose management focuses on return on capital.

“What we don’t like is sitting there with assets year in and year out with no attempt to crystalize or drive values and collect trophies. There is a role for conglomerates, but not for those with a lazy capital structure and a big discount to net asset value.”

A double whammy in the Hong Kong economy — China’s slowing economy and an upcoming rate hike in the United States which will raise the cost of capital in the pegged economy — is reining in the local market, but Hudson believes buying into a more diversified conglomerate and insurance will help spread investment risks.

“The good thing for Hong Kong is that world-class regional global business is listed here,” Hudson said. “They have been around for many years. They have good export market globally, and a strong US economy and rebounding European market will help.”

As such, Schroders sees values in traditional sectors such as textile, capital goods and basic electronics.

Hong Kong’s property sector makes an interesting case because it is heavily concentrated in the economy but it has mostly gone sideways despite a physical market that doubled in the past four years.

“The stock and physical markets have been detached for a long time, but there are lots of value in Hong Kong assets, although we may worry about property softness as rates start going up slowly in the second half which should not do too much damage,” he said.

“But these companies have a conservative balance sheet, many of which have net cash. We are not sure what will happen in the next three to four years but we know these companies will be here.”

For China, Hudson sees a huge disconnect between what happens in the economy at the GDP level and the broader market in terms of driving shareholders’ return and value.

Hudson bought into the investment themes of disruptive internet, service healthcare and rebalancing economy but not in the theme of state-owned enterprise reform.

“There will be corporate action, and mergers, but are they real reforms?” he asked. “This is the reform, not western-style cost-cutting. I think everything in China is driven by local priorities and we have not seen today how shareholders’ value creation will come in.”

Ben Kwok contributed this article.

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