BY ALLEN T. CHENG
| Hedge fund vets: V-Nee Yeh (top) and Cheah Cheng Hye, co-founders of Value Partners (Photographs by Philipp Engelhorn) |
GOME ELECTRICAL APPLIANCES Holdings, one of China’s largest electronics retailers, has fallen a long way since its heyday in 2007, when the stock traded at about HK$20 ($2.56) per share. The company’s chairman, Huang Guangyu, was arrested in 2008 and sent to prison for stock market manipulation in 2010. Although the scandal is now safely behind Gome, the company’s stock has yet to recover, falling to HK$1.45 on April 11 of this year — its lowest level since 2009. But to value investor Cheah Cheng Hye, the retailer is starting to look interesting. The company, which already holds a leading position in China’s first-tier cities, is expanding into other markets where demand is high and there is not much competition. And it’s making moves to expand its market share even further, developing an e-commerce platform and striking strategic alliances with telecommunications companies. Cheah, chairman and co-CIO of Hong Kong–based Value Partners Group, began building a position in Gome in January of this year; as of March 31 that position accounted for roughly 2 percent of the assets in the firm’s flagship fund. It is the single largest retail holding in Value Partners’ Classic Fund.
The investment is trademark Cheah, whose firm now manages $8.2 billion and is Asia’s largest hedge fund company. Cheah says that every investment he makes is the result of what he calls a 360-degree cross-checking of research. Before he decided to load up on Gome shares, his analysts not only interviewed the retailer’s current senior executives but also questioned dozens of midlevel managers, suppliers, bankers and customers before coming up with the investment thesis that the stock was oversold and that there was a gap between the market’s expectations and how the company would likely perform.
For the 58-year-old Cheah, who started his career three decades ago as a crime reporter for a Malaysian newspaper, there is no replacement for solid due diligence and dogged investigative work when it comes to uncovering the facts about a company. This isn’t just lip service. The former journalist isn’t above sending his analysts on stakeouts or making them pose as customers to see whether company insiders are lying to them. In his relentless pursuit of value, Cheah has led some market observers to call him Asia’s answer to Warren Buffett.
Cheah almost always takes a long-term perspective and seldom trades in and out of equities. His bottom-fishing has helped his firm beat the market consistently, including in 2011, one of the most volatile years in recent history for the Greater China region. Value Partners’ Classic Fund, which had $1.75 billion in assets as of March 31, lost 17.2 percent in 2011, compared with a 17.4 percent drop in Hong Kong’s Hang Seng Index and an 18.4 percent decline in the MSCI China Index. The Classic Fund has outperformed both indexes every year since it was founded in 1993 except for the two, 2005 and 2007, when it underperformed the MSCI China Index; it has made money in 14 of its 19 years in existence.
Value Partners runs several hedge funds, along with managed accounts for high-net-worth individuals and institutional investors, co-branded funds and six funds that are accessible to Hong Kong–based retail investors. The firm’s funds invest only in Asian markets, particularly China--related equity markets in Hong Kong, and Cheah says he has no plans to invest elsewhere despite the market downturn last year and fears of a potentially severe China slowdown. Most of the funds fundamentally take long-term approaches based on investment themes and short only when macroeconomic factors turn against certain equities in the portfolio mix, Cheah says.
Still, last year’s losses were painful. Portfolio losses of $1.6 billion more than offset net inflows of $847 million, causing assets under management at the firm to drop 9.9 percent for the year. Value Partners’ net income fell 74.4 percent last year, to HK$167.3 million, reflecting a steep decline in performance fees. These fees fell by 80.3 percent, to HK$139.5 million. Markets were driven by fears that the Chinese economy was heading toward a hard landing, mainly because of overheating in the country’s property sector. The government forced banks to call in loans to major developers and many companies in an effort to slow down investments in real estate. This drove down home prices last year; they had tripled in the previous three years in the major cities.
“We’re good at stock picking, but we’re not as good at reading macroeconomic policies,” Cheah says of the firm’s performance last year, adding that he was surprised by the severity of the impact the European debt crisis had on China’s equity markets. “What we discovered is, we must closely follow central bank policies,” he explains. “There were multiple unfortunate events that were unforeseen, including the Greek debt crisis, which hammered markets globally. In this macro-driven market, the guys who do well are the guys who read the macro decisions. There are very few such people, and even fewer who do this successfully.” Despite the decline in 2011, long-term investors in Value Partners’ funds have enjoyed significant gains over the years. The Classic Fund has delivered annualized compounded returns of 17.1 percent since 1993, when Cheah and partner V-Nee Yeh co-founded the firm.
Stanley Tsai, Hong Kong–based asset management industry analyst for Keefe, Bruyette & Woods, says the New York–based investment bank has an outperform rating on Value Partners, which became the first asset manager to list shares on the Hong Kong Exchange in 2007. “One of the reasons we are positive on the stock is that throughout the volatility we saw last year, fund redemptions have remained relatively stable,” Tsai says. “By contrast, fund outflows have hurt most other global fund managers. This gives the firm substantial leverage to boost earnings when performance recovers.”
Many Value Partners investors remain confident in the firm and say they believe China will continue to grow, albeit at a slower pace. The country’s gross domestic product slowed to 8.1 percent in the first quarter of 2012, worse than many analysts expected and its slowest rate since the start of 2009. China’s 2011 GDP growth was 9.2 percent, down from 10.5 percent in 2010. Still, Hugh Culverhouse Jr., a Sarasota, Florida–based hedge fund investor who has $9 million in six Value Partners funds, says he is optimistic about China’s future and thinks Value Partners will likely outperform the market because of its disciplined approach.
“I don’t see China collapsing like what doomsayers say,” says Culverhouse, whose father once owned the National Football League’s Tampa Bay Buccaneers. He adds that Value Partners “will get it right a lot more often than otherwise.”
Louis So, Cheah’s co-CIO, says the firm’s investment team tries to get it right by doing as much due diligence as humanly possible, including face-to-face interviews with executives and an average of 2,500 company visits a year. To manage risk and gain insights across various industries, Cheah and So split the group’s 40 analysts into six teams that cross various sectors, including automobiles, electronics, manufacturing, telecommunications, metals and commodities.
“Our research method is very in-depth,” says So, 36, who joined the firm in 1999, shortly after he passed his certified public accounting examination and graduated with a master’s degree in commerce from the University of New South Wales in Australia. “We tend not to rely on sell-side analysts. We get everything firsthand. We interview industry experts, competitors, suppliers, government officials.”
All Value Partners analysts are required to conduct undercover investigations. If an analyst is recommending an investment in a specific listed auto dealership company in China, for instance, the report must also contain data from competitors, says So. “It means the analyst must pretend to be a customer or take on another role for the sake of getting information from rivals of the auto dealership company,” So says.
Cheah requires analysts to test information that CEOs and CFOs tell them. When top managers of an automaker, for example, tell a Value Partners analyst that sales are up, the analyst can’t just take their word for it. “They must leave that meeting and come back disguised in a car and sit outside the factory and count the trucks leaving for days and over different periods of time to see if they are being told the truth or being lied to,” Cheah says, adding that most traditional investment banking equity analysts refuse to conduct such investigative research. For this reason, Cheah doesn’t like to recruit analysts from the major banks. “I prefer to hire young people out of college in Hong Kong — people who don’t have experience, are willing to listen and are willing to be trained,” he says.
CHEAH CREDITS PART OF HISsuccess as an investor to the years he spent slaving away as a reporter in Hong Kong’s smoke-filled newsrooms, starting in the mid-1970s. Back then it wasn’t unusual for editors on deadline to openly drink alcohol while barking rude comments at underlings. Though Cheah didn’t mind being criticized, one day he couldn’t resist trying to defend himself. The next thing he knew, the editor had hurled a ten-pound Olivetti typewriter at his head. Cheah ducked, and the typewriter crashed to the floor.
Born into a poor ethnic Chinese family in Penang, Malaysia, Cheah would labor as a journalist for another decade, for publications including the Far Eastern Economic Review magazine and then the Hong Kong–based Asian Wall Street Journal. He changed professions in 1989 when U.K.-based brokerage Morgan, Grenfell & Co. offered him the chance to make “a small fortune,” as he recalls, starting its first Asian equity research team. But to this day he is grateful for his years in journalism, which he says taught him at least one golden rule: “Always ask the who, what, when, where, why and how,” he regularly tells his analysts.
Since co-founding Value Partners with $5 million in assets, Cheah has been training his analysts — some of whom have CFAs, CPAs and MBAs — in basic journalism skills so they can do their own investigative reporting rather than relying on recommendations from sell-side analysts. Cheah requires each analyst to visit an average of five companies a month to interview executives and get firsthand insight.
“Being an ex-journalist helps,” says Cheah, who began his career as a crime reporter for Malaysian newspaper the Star in 1971. “A lot of the work we do is trawl for information. The raw material of our work is information, and based on synthesizing information we formulate investment strategies and the best stock picking.”
Another signature Cheah trait: an unwavering focus on value investing. He and his team search for undervalued stocks with huge upside potential, especially among companies with small to medium-size market capitalizations that are more or less ignored by the equity analysts of the large investment banks. “Most investment analysts in Hong Kong back then covered only the top 33 index constituents or blue-chip stocks,” Cheah says in recalling his sales pitch to Morgan Grenfell in 1989. He proposed that the bank focus only on small-cap and midcap stocks, in a successful meeting that paved the way for his transition from reporter to investment analyst. “I could cover the other 300-plus companies, and I could do a better job, and it would differentiate Morgan Grenfell,” he says.
Morgan Grenfell immediately named Cheah head of research. Though he didn’t strike it rich that first year — his low-priced stock approach didn’t catch on with the firm’s institutional clients — he begged his bosses in London to give him seed money to set up a proprietary trading desk, and they agreed. When U.S. president George H.W. Bush launched the Gulf War in 1991, Cheah was manning his computer trading accounts, going in and out of the small-cap stocks that most major funds ignored. “On the first day of war, the market shot up, so I sold on rumors and bought on dips,” Cheah says. “We made a lot of money.”
For the money he earned trading for Morgan Grenfell, Cheah received more than $1 million in bonuses. He was 38 years old — not young or wealthy by investment banking standards but very successful considering he had been a poorly paid reporter just a few years before. That nest egg gave him the desire to launch something on his own. In 1993, Cheah’s friend Yeh, scion of a wealthy Hong Kong family that controlled a construction and real estate group, approached him about going into business together. Yeh had just returned from New York, where he had earned a JD from Columbia Law School and acquired a taste for Wall Street’s energy while working for six years as an investment banker at Lazard Frères & Co.
The two set up Value Partners in a little office in Wanchai, a commercial neighborhood near Central, Hong Kong’s financial district. The room had three desks — one for Cheah, one for Yeh and one for a secretary — and was located in a corner at the headquarters of property and construction company Hsin Chong Group, which Yeh had just delisted and privatized.
The two began implementing Cheah’s investment strategy of focusing on undervalued small- and medium-cap equities. Of their $5 million fund, $2 million came from Yeh, $2 million from his family and friends, and $1 million from Cheah. The strategy worked: The pair produced a 63 percent gain in the firm’s first year, winning the attention of Hong Kong’s major English-language newspaper, the South China Morning Post. In 1994 the paper named Value Partners “money manager of the year.”
“At that time, hedge funds were very novel in Asia,” says Yeh, 53, who today is honorary chairman of Value Partners and no longer involved in the company’s management on a daily basis. (He is spending most of his time seeding small hedge fund start-ups.) “We were also lucky: 1993 was a raging bull market. We were small in assets, but we delivered good performance,” Yeh recalls.
That performance drew the notice of global institutional investors. By 2000, Value Partners’ assets had topped $116 million. A decade later they’d grown almost 68 times, to $7.9 billion.
“We respect Cheah Cheng Hye very much,” says Raymond Wong, chief executive of Cheetah Investment Management, a Hong Kong–based firm that specializes in seeding hedge funds. “We believe value-oriented fundamental stock picking and his focus on due diligence work well in many Asian markets. There are a few funds and managers we seeded that operate in Japan, Korea and Asia ex-Japan on that basis. There is still plenty of room for growth.” Cheetah, in which Yeh has a small equity stake, has $600 million in assets under management and so far has seeded six hedge funds, which collectively manage $1 billion.
Value Partners co-CIOs Cheah and So pride themselves on the exhaustiveness of their research. Every year they and their analysts look at the entire universe of 6,000 listed companies on the Hong Kong, Shanghai, Shenzhen and Taiwan stock exchanges. They whittle the numbers down, deciding which are undervalued and which ones to visit. Value Partners ends up investing in roughly 100 companies.
Despite all the due diligence, Value Partners hasn’t been able to completely avoid some of the chicanery among Chinese companies. The firm more than likely lost a substantial sum of money in 2011 after investing in Real Gold Mining, a medium--size Chinese miner that the Hong Kong Exchange suspended from trading after regulators found that company executives had misrepresented information in their financial disclosures.
So says that he can’t reveal how much might be at stake and that he won’t know until Hong Kong regulators complete their investigation. He adds that Value Partners generally never bets more than 4 to 6 percent of any one of the 41 portfolios the firm manages on any one entity.
Value Partners has a “no blame” culture. “The key is to focus on lessons learned and not to repeat mistakes,” So explains. “In this case the conclusion is to try not to invest in small to medium-size mining companies. If we invest, we tend to invest in the biggest miners. That’s because it is difficult to do due diligence at a miner, especially a small one.”
The Classic Fund’s biggest losers last year were real estate companies. The stock price of Evergrande Real Estate Group, which makes up 5.2 percent of the fund, fell by approximately 19 percent in 2011, while China Vanke Group, which accounts for 3.6 percent, lost 15.1 percent on the back of the Chinese government’s campaign to deflate real estate prices.
Gains in most of the fund’s top ten holdings helped ease the pain. These holdings collectively made up 49 percent of the Classic Fund and constituted China’s strongest growth sectors: automobiles, energy, financial services, real estate and technology.
The biggest winner was Brilliance China Automotive Holdings, one of China’s largest automakers. The company, which constitutes 7.2 percent of the portfolio, gained 32.5 percent for the fund in 2011 as a result of growing consumer demand for automobiles. (China overtook the U.S. as the world’s No. 1 auto market in 2010.) China’s Lenovo Group, 3.3 percent of the portfolio, gained 9 percent for the fund in 2011 as it overtook Dell to become the world’s second-largest computer maker. China Oilfield Services, the country’s largest supplier of oil rigs and equipment, gained 16.7 percent for the fund as a result of rising consumer demand for energy and petroleum.
“Although we are bottom-up stock pickers, whether consciously or unconsciously, we are following major themes of China’s development,” Cheah says.
As insurance against volatility this year, Cheah will increase exposure to companies that benefit from China’s rising consumption. He also intends to move more assets into cash and gold, which made up 2 percent and 9 percent, respectively, of the Classic Fund at the end of 2011.
“We want to make sure the portfolio remains resilient,” Cheah says, adding that he will continue to short individual equities and the index futures when they merit shorting in the months ahead. He refuses to disclose the equities he is currently shorting or will be shorting, or the timing of such actions.
How Value Partners will fare in the years ahead depends on the fate of the Chinese economy. And not all China experts are as optimistic as Cheah.
“If China fails to transform its development pattern over the next five years, then the risks of a major crisis could increase exponentially,” says Hong Kong–based Huang Yiping, Barclays Capital’s chief economist for emerging Asia, referring to China’s overreliance on government-investment-led growth. In the past the government always stretched the financial and fiscal systems to contain near-term downside risks, Huang says, adding that there is a limit to how much longer this approach can be employed. After the 1997–98 Asian financial crisis, Huang notes, it took years for China to reduce local government debt. “But China may not always have the luxury of a long adjustment period to deal with such problems,” he says.
China is at a crossroads: If policymakers are able to spread the wealth beyond the cities into the countryside and give more room and sustenance to the private sector, growth will be sustainable. If not, a crisis looms, as the gap between the rich and poor, and the cities and the countryside, will accelerate. Chinese Premier Wen Jiabao articulated essentially that at the closing press conference of the National People’s Congress in March 2007. “China is on a path of unbalanced, uncoordinated and unsustainable development,” he said.
Cheah, however, still thinks that Value Partners’ future lies intractably in China, and to that end the firm is preparing to move into the mainland. Value Partners spent 41 million yuan ($6.5 million) earlier this year to acquire a 49 percent stake in Shanghai-based KBC Goldstate Fund Management Co. from Belgium’s KBC Asset Management. The remaining 51 percent stake is held by Goldstate Securities Co., a Shenzhen brokerage firm. The move allows Value Partners to diversify into traditional asset management in China by working with its local partner to offer long-only fund products, Cheah says.
“Assuming China will continue to grow, we will gather our fair share,” Cheah says. “We have to invest in China, and our projects there complete our network as a Greater China–focused company.”
But Cheah says he also is realistic. “By 2020, China will be bigger than the U.S. economically, but at the same time, there will be more old people than young people,” he explains. “China’s growth will be easing off into the indefinite future. The risk for China is that it gets old before it gets rich, before it becomes a midincome country.”
Cheah is preparing Value Partners for the day when China’s growth slows. Though he won’t say what his strategy will be then, there is no question that one thing will remain the same: intense due diligence. “Even in a slower-growth economy, companies that are well managed will be winners,” says Cheah. “And there always will be plenty of undervalued opportunities.” AR
