Sometimes it’s not a good idea to bet on the house. That’s the current view of Praveen Choudhary and his colleagues on Morgan Stanley’s eight-member gaming and lodging team in Asia. The Hong Kong–based crew chief has been resolutely downbeat on Macau’s casino stocks over the past couple of years. Lately his judgments have grown even more jaundiced.
Citing a sea of troubles for the gambling houses — loss of revenue from the continued decline in VIP junkets, an oversupply of hotel rooms, rising operating costs, China’s crackdown on corruption and even an across-the-board smoking ban — Choudhary and his associates downgraded MGM China Holdings and Sands China from equal weight to underweight in July. They are now officially bearish on five of the six important gaming houses they follow in Macau. Only Galaxy Entertainment Group is rated equal weight — and that’s because the casino has been taking market share from its competitors.
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But even as they preach doom and gloom — the researchers lowered estimated revenue declines for 2015 from 26 percent to 34 percent and forecast that annual earnings per share will plummet by anywhere from 19 percent to 29 percent, depending on the casino operator — they make room for a possible upside thesis. For example, they acknowledge that Macau’s government has been relaxing rules on transit visas, that mass revenue per Chinese visitor has stabilized, that the number of hotel guests has been improving in recent months and that Macau’s legislative assembly could adopt less-restrictive smoking rules.
It’s this practice of always providing both sides of the story, says one hedge fund client in Singapore, that leads him to especially value Morgan Stanley’s analyses. “One thing that Morgan Stanley forces its analysts to do,” this source says, “is include both a bear case and bull case for the stock.” This investor also appreciates that the researchers frequently include tactical recommendations. For example, he says, they might have a buy position on a stock and “yet in the short term, they’ll issue a sell rating. It’s unique.”
This hedge fund manager is hardly alone in his appreciation of the firm’s regional research offerings. Institutional Investor’s Alpha recalculated the results of this year’s All-Asia Research Team survey using only the votes cast by hedge fund participants. Morgan Stanley not only captures first place overall, its analysts are deemed the best in 26 of the 30 sectors in which the firm appears. In second place is Bank of America Merrill Lynch, with 29 positions, followed by Credit Suisse, with 25; these firms claim two first-place positions each. Rounding out the top five, with 23 and 21 spots, respectively, are UBS and Deutsche Bank.
To view the full list of 13 firms on this year’s roster, click on the Leaders link in the navigation table accompanying this article. To view the crews in first, second and third place in each of the 32 sectors that produced publishable results, plus runners-up (where applicable), click on Hedge Funds’ Favorite Asia Research Teams.
Survey results reflect the opinions of more than 830 hedge fund managers at nearly 360 firms overseeing an estimated $163 billion in Asia (ex-Japan) assets.
Despite such an impressive showing with hedge fund investors, Morgan Stanley does not offer preferential treatment to this particular type of client, insists Neil Perry, the firm’s Hong Kong–based director of Asia-Pacific Research. “Hedge funds are very important clients, but there is no explicit research for any segment of our client base,” he says. “What investors consistently ask for is high-quality and thought-provoking research. What we encourage at Morgan Stanley is in-depth, fundamental research and a very high level of collaboration among sector analysts.”
If hedge fund managers want to test their individual theses, Perry adds, the firm’s analysts are encouraged to engage in robust discussions — but that goes for all clients. In any case, it’s impossible to offer one-size-fits-all investment counseling to hedge funds, which come in many different shapes and sizes, he points out.
Simon Garing, deputy director of Asia-Pacific equity research at BofA Merrill in Hong Kong, similarly asserts that his firm “treats all of our clients the same” in the release of analysts’ opinions and ratings. “In terms of service levels and understanding which investment style each fund adopts,” he adds, “we clearly tailor our efforts to suit each one.”
Hedge funds appreciate that BofA Merrill’s 200 research analysts take a “disciplined, bold approach in their coverage of 1,200 stocks across the Asia-Pacific region,” Garing contends. The firm currently has assigned 12 percent fewer neutral ratings than the Street’s average, 10 percent more sell ratings and 2 percent more buys, he reports.
Moreover, its analysts produce big-themed reports that are often popular with hedge funds. One example is “Vanity Capital: the Global Bull Market in Narcissism.” In this publication, which appeared in April, they estimate that consumers worldwide spend $4.5 trillion annually — an amount larger than the $3.7 trillion gross domestic product of Germany, the world’s fourth-largest economy — “to augment self-confidence by enhancing one’s appearance and prestige.” The report reels off a festival of spending on fashion and beauty products and services, including health supplements, face-lifts and other cosmetic surgery.
China (including Hong Kong and Taiwan), with a 15.6 percent annual growth rate in self-centered spending, outpaces the world. South Korea ranks second, with a 12.4 percent pace; and India is third, at 10.7 percent. (U.S. expenditures increase by 4.4 percent each year.) “We’re always trying to find emerging macro trends other than that China’s economy is slowing down, which is obvious,” Garing observes.
One noteworthy trend among hedge fund investors that Credit Suisse analysts have discerned is an increasing willingness to invest in private companies, according to Ernest Fong, Hong Kong–based head of Asia-Pacific equity research. “Over the last 12 to 18 months,” he says, “we’ve witnessed a lot more hedge funds taking stakes in Internet and media companies in China ahead of their coming to market.”
Although his analysts don’t conduct research on unlisted names, “a number of hedge funds have asked us to arrange for them to visit private companies so they can kick the tires,” Fong says, “and they’ll ask analysts for reports [on listed competitors] to help them understand the industry landscape.”
He also sees convergence as both hedge funds and long-only investors pursue absolute returns. Even as many in the latter group opt for passive investing in indexes and exchange-traded funds, “a lot of active long-only funds are asking for actionable ideas, and there’s been a pickup in requests for more thematic research,” he notes.
In response, Credit Suisse began issuing a monthly focus list of 12 to 20 stocks, making changes on an ad hoc basis. Since its inception in April 2014, the portfolio has generated a total return of roughly 25 percent and outperformed the regional market by 20 percent, Fong reports.
His colleague Di (Dick) Wei, who helms the six-member crew that claims first place in the Internet sector, wins praise from hedge fund managers for an October contrarian downgrade from neutral to underperform on the American depositary receipts of China’s Jumei International Holding, an online cosmetics retailer. Citing seasonally low demand and intensifying competition, among other factors, the Hong Kong–headquartered analysts predicted that earnings would disappoint. They were right. In November the company reported that its gross profit margin had fallen from 25.9 percent to 22 percent year over year in the third quarter.
In mid-December, after the ADRs had plunged 41.4 percent, from $23.02 to $13.50, and trailed the broad market by 40.1 percentage points, the team upgraded Jumei to neutral. Since then the shares had climbed back 23.9 percent, to $16.73, through mid-August.
“[Wei] has a very good team, knows most of the stocks and understands the drivers of price movements better than anyone else covering the sector,” one client insists. “When you compare his calls with those of his competitors, he’s more accurate — and he’s really fast.”
Citi’s Kam Keung (Oscar) Choi, leader of the 11-strong squad that finishes first in Property, says hedge fund clients are very different from long-only investors, which are mainly interested in top-down research. “Hedge funds focus on ideas and themes, especially in the short and medium terms,” he says. “Our sector has so many moving parts that it’s good for hedge funds.”
For a short play it’s hard to match the team’s advice on Agile Property Holdings, a Chinese real estate development and management concern. The researchers downgraded Agile from neutral to sell in March 2014 and slashed their target price from HK$9.15 to HK$5.70. Their chief criticism of the company was its overexposure to tier-3 and tier-4 cities — respectively, those with populations ranging from 1 million to 2 million and those between 300,000 and 500,000. Many of these urban areas have weak economies and are losing population, the Hong Kong–based team leader reports.
Last fall Agile’s chairman, Chen Zhuo Lin, was placed in governmental custody for two months amid an investigation for graft and corruption. He was released in December without being charged.
By mid-August 2015 the stock had plunged 33.9 percent, from HK$6.28 to HK$4.15, and the analysts remain bearish. “We don’t believe management when they say there can be a turnaround,” says Choi.
For those hedge fund investors that do appreciate a top-down perspective, the best quantitative research is that produced by the BofA Merrill crew captained by Nigel Tupper. Each month the Sydney-based analyst — who calls himself “a quant for nonquants” — and his squad boil down a plethora of economic and business statistics from 50 countries into a tight summary called “The Global Wave.” The report “cuts through all the noise and tells investors where we are in the cycle and whether the global economy is improving or deteriorating,” he explains.
Lately, he and his associates have been focusing on the concept of growth versus value. “Over the past 12 months, growth stocks have been performing very well, while value stocks have not,” Tupper observes. “Many investors think value investing always works and that cheap stocks will always outperform. But in a mild earnings environment in Asia, where profits are muted, investors are not buying cheap cyclicals. They’re paying a premium for quality — stocks with price-to-earnings ratios of 30-plus.”
The team continues to steer investors away from value stocks — especially in the energy, materials and industrials sectors, which the researchers expect to continue to underperform — and toward such growth plays as Internet stocks in China and technology issues in Taiwan. If that sounds counterintuitive, so be it: “My role is to prove or disprove commonly held investment beliefs,” Tupper maintains. “I never say anything that the numbers don’t indicate.”
He and his colleagues also compile a monthly model of the region’s 20 best stocks, named Contenders, and 20 worst, dubbed Defenders. In the year through April, he reports, the Contenders boasted a 42.3 percent return, while the Defenders lost 5.3 percent. During the same period, Asian stocks advanced 8.2 percent.
“It’s been a particularly good year for quant strategies,” Tupper declares.
