The Asian Analysts That Hedge Funds Rate Highest

To understand why the Morgan Stanley researchers directed by Chia Ao (William) Lu — better known as Bill — are so popular with hedge fund clients, consider their contrarian upgrade of Taiwan Semiconductor Manufacturing Co. in March 2011. At the time, the tablet market was maturing, and the Street’s consensus was that demand for semiconductors would remain in the doldrums. Few analysts were upbeat about the prospects for TSMC, the world’s largest contract chip-maker, but Lu and his associates upgraded the shares from equal weight to overweight and raised their target price by 25 percent, to 85 New Taiwan dollars.

“The Street is concerned about a potential glut of tablets,” Lu wrote in a report that month. But laptops were becoming “a very small contributor” to the company’s bottom line, he pointed out, while sales of smartphones were poised to explode. “The mobile Internet represents a significant opportunity for TSMC in terms of unit growth, content per box and market share,” he noted.

And explode they did. Smartphone sales jumped 58 percent year over year in 2011, to 472 million units worldwide, according to Gartner, a Stamford, Connecticut–based information technology research firm. By the end of 2012, that figure had soared to 680 million devices.

In mid-April 2013, with TSMC’s shares up 54.5 percent, from NT$61.83 to NT$95.52, and ahead of the sector by 18.1 percentage points, Lu downgraded them to equal weight. “We felt that the upside was mostly priced in, and smartphone commoditization, technology barriers and competition would be headwinds,” the Hong Kong–based analyst explains.

Lu’s fans include Frank Wang, president of Athena Capital Management Corp. in Taipei. “He’s a contrarian,” the hedge fund manager says approvingly, “and he can be audacious.”

Those are qualities that many hedge funds admire in sell-side researchers. Although Lu’s squad finishes third in this year’s All-Asia Research Team, Institutional Investor’s annual ranking of the region’s best equity analyst teams, hedge fund managers believe that no one covers the Technology/Semiconductors sector better. Nor is this group the only one held in higher regard by these money managers. To find out who are their preferred research providers, Institutional Investor’s Alpha recalculated the results of this year’s All-Asia team using only the votes cast by hedge fund respondents. Morgan Stanley leads the lineup for a second consecutive year, earning a spot in all but one of this ranking’s 31 sectors and claiming first place in 14 of them. Bank of America Merrill Lynch, which shared the winner’s circle last year, slips to second place, with 26 spots, nine of which are for sector-topping performances. Credit Suisse and Deutsche Bank return in third and fourth place, respectively, with 22 and 21 positions. UBS, with 19, slips one level to fifth place. These results reflect the opinions of more than 680 hedge fund managers at 323 firms that collectively manage an estimated $123 billion Asia ex-Japan assets.

The winning squads in each of the sectors that produced publishable results can be found in the table on page 46. Additional survey data can be found online at institutionalinvestor.com, and full results of the broader survey are at institutionalinvestor.com/asrt.

Many of the stereotypes associated with hedge funds are inaccurate, according to Neil Perry, director of Asia-Pacific research at Morgan Stanley in Hong Kong. “It’s a common misperception that hedge funds trade on short-term information or short-term bets or are less fundamental,” he says. “Deep fundamental long-term research is what both hedge funds and long-only clients value.”

Stephen Haggerty, Perry’s counterpart at BofA Merrill, concurs. “All types of funds want to generate superior returns, and research is key to that,” he asserts. Even so, the Hong Kong–based research director believes there are “measurable differences” between the two approaches. “Hedge funds are more likely to use financial models, whereas long-onlys are more likely to spend time on the phone with analysts,” Haggerty observes. “These reflect not only differences in investment styles but in staffing, experience and individual personalities.”

Hedge fund clients on the prowl for actionable ideas have been supportive of what Haggerty calls BofA Merrill’s “stock-picking culture.” Highlighting the right investments “is an important part of an analyst’s skill set,” he says. “Our view is that stock calls assist a client’s approach, whether it’s basing an investment decision on a financial model, industry data or valuation.”

The firm imposes restrictions on the number of neutral ratings an analyst may issue at any given time, a practice that “forces them to take a stand with a buy or underperform rating,” Haggerty says. The firm found that its neutral calls number about 10 percent fewer than its competitors’.

Ernest Fong, Credit Suisse’s Hong Kong–based head of Asia-Pacific equity research, reports that his firm deploys a dedicated hedge fund sales team that relays constant feedback. This, he says, permits sell-side analysts to stay abreast of hedge funds’ thinking and identify ideas that will appeal to an audience that “pays close attention to arbitrage opportunities and frequently has mandates for investing in special situations.”

These investors are also able to broaden their investment choices “beyond listed stocks to such vehicles as convertible bonds, derivatives, debt and private equity investments,” Fong adds. “In the usual day-to-day activity, they usually don’t require a differentiated approach, but as valued clients they have the ability to tap the expertise across the spectrum of our global investment bank.”

The asset management industry has changed a lot in recent years, contends Damien Horth, who directs Asia-Pacific equity research at UBS and divides his time between Hong Kong and Tokyo. “Now you have a number of very large, very established hedge funds, and they’re as far away from ‘two guys and a Bloomberg’ as you can get,” he says. In addition, “the regulatory environment has become increasingly invasive in the years since the financial crisis. The environment is less forgiving, and pretty much everyone on both the buy side and sell sides is under greater scrutiny.”

The changes have prompted many portfolio managers to alter their approaches. “It forces everyone to shun the kind of short-termism that tries to develop an edge just by anticipating next quarter’s earnings,” Horth maintains. “Now, as you try to build an investment thesis, you have to consider macro conditions and how they evolve, industry structures, changes in competitive dynamics, the pace of technological change and the profit pool for an industry. That’s a different type of research. It’s more labor intensive and effectively forces investors up the value curve.”

One Hong Kong–based hedge fund manager likes to engage in “what if” discussions with analysts about global issues and Asian corporates: “We’ll ask them, for example, ‘Will there be Indonesian bank consolidation? Will Sony buy out Sony Financial? Will [Australia & New Zealand Banking Group] and Standard Chartered Bank merge? Is the deal possible? Is financing available? Is the deal accretive? What would happen to the stock price? Do they think the companies are becoming more acquisitive?’”

Responses vary. “Not all analysts are willing to have this conversation,” this portfolio manager reports. “They’re so fixed in their thought processes that they can’t think laterally. It’s easy for them to dismiss such questions, but the better analysts will spend time on a scenario analysis with you.”

Hedge fund managers also have a soft spot for analysts whose research cuts against the grain. The team that ranks highest in Internet, the Credit Suisse crew directed by Di (Dick) Wei, is praised by one money manager for its contrarian stance on China’s Bitauto Holdings, which provides online services to that country’s automobile industry. Many analysts are disdainful of Bitauto “because it has a lot of employees for an Internet company,” this New York–based client says. “They interpret that as a negative, but Wei actually highlights this as a positive.”

A human workforce is needed to maintain relationships with auto dealers and prospective customers, the Hong Kong–based team leader explains. “Our surveys told us that Bitauto is one of the more important channels that dealers use to attract potential car buyers,” Wei adds. “We also found that the percentage of online spending is still below traffic into the dealers’ showrooms. It could be quite a lot higher.” In mid-April, when the New York Stock Exchange–listed shares were trading at $30.77, the analysts initiated coverage with an outperform rating. By mid-August they had skyrocketed 140.5 percent, to $74.01, and soared past the sector by 124 percentage points.

Jain Gaurav, senior research analyst of London-based Altavista Capital Group, becomes animated when talking about Morgan Stanley’s coverage of Asia’s telecommunications names. The top-ranked team is captained by Navin Killa, who is headquartered in Hong Kong. Gaurav hails Killa’s group for its bearish stance on mobile operators in Taiwan. “These were out-of-consensus calls,” an appreciative Gaurav recalls. “They don’t hesitate to underweight stocks that are overpriced.”

In late December 2012 the Morgan Stanley analysts informed clients that Taiwan’s mobile communications market was maturing — penetration was nearing 40 percent, and 50 percent is considered saturation, Killa says. Among the stocks they downgraded from neutral to underweight were Far EasTone Telecommunications Co. and Taiwan Mobile Co., companies that were experiencing only incremental revenue growth, he adds, and remained saddled with fixed costs. By mid-August, Far EasTone shares had slumped 8.3 percent, to NT$63.20, while Taiwan Mobile’s had fallen 5 percent, to NT$93.50. During the same period the sector gained 7.8 percent.

Killa’s colleague Jasmine Lu, who heads the squad that ranks highest in Technology/Hardware, is also a favorite of Athena Capital’s Wang. “She’s always bringing ideas forward, and she makes bold forecasts,” the money manager says.

“The best time for returns is a nonconsensus call that’s misunderstood by the Street,” the Taipei-based analyst observes. “But be sure you’re right.” Because China can “sometimes be a black box where data points are not that transparent,” she adds, building a contrarian case can be tricky. “We’ll talk not just to the company but to competitors, upstream and downstream suppliers, as well as to players in different sectors, customers and the government.”

In April, Lu and her associates pounded the table on China’s AAC Technologies Holdings, a maker of headsets, microphones and other devices, on the belief that the market for these products is “just starting to take off,” she says, and that the company could enjoy “double-digit year-over-year unit growth.” The stock surged 16.4 percent, from HK$40.77 to HK$47.45, and bested the sector by 3 percentage points, through mid-August. The team has a target price of HK$57.

“This is a market with great opportunities,” she says of China’s hardware sector, noting that companies like AAC are experiencing rapid growth, although structural changes and upheaval are also taking place. “But there’s also great risk.”