Q&A with Andrew Mattock, Henderson Fund Manager: An update of the performance of the Henderson Horizon China Fund

Andrew Mattock is the lead fund manager of the Henderson Horizon Fund – China Fund, which has delivered +126.6% over the last 6 months versus the index performance of +47.5%.




The Chinese domestic market and related H shares have risen a fair bit in April and May. Investors think a correction may come soon, is it still timely to invest in Chinese equities?


The strong recovery of equity markets this year has caught a lot of investors by surprise. Loose monetary conditions, aggressive government policies, improved risk appetite and a steady pick-up in economic activities have been the major drivers for this strong rally since March. This has been a valuation-driven rally as stocks were excessively oversold at the beginning of the year.

Valuations were previously too cheap and at this point, we think that lots of that ‘valuation cheapness’ have already been taken out of the markets. That said what we are seeing now is more compelling evidence that the Chinese economy is recovering such as the Chinese Purchasing Manager’s Index (PMI) for May showing the country’s manufacturing industry expanding for a third month.






We believe that the next stage of the rally will likely be driven by earnings upgrades and we will see value start to re-emerge as price earnings (PE) multiples drop. If you take the Hang Seng China Enterprises Index, which tracks the so-called H shares of Chinese companies listed in Hong Kong, it peaked at around 20,400 in October 2007. The index, which tracks 43 stocks, has rallied 33% this year on speculation that Premier Wen Jiabao's stimulus package is working.

We are currently seeing it at 10,000 so the market will have to go up another 100% from here before we revisit the lofty highs seen in 2007. You could also argue that those lofty highs did reflect quite a lot of overvaluation in the market. Currently, what we have yet to see is the impact of earnings coming through but we think that the index may rally to 15,000 in the next 12 months as earnings recover.

More people are starting to believe that a sustainable recovery in the Chinese economy is possible. Even though the sentiment effect from the rest of the world is still weighing in on the market, we think that the next stage for Chinese equity markets is a recovery rally which will see a massive earnings cycle come through in terms of corporate profitability. This potential earnings upgrade cycle coupled with a lift in global sentiment could see the market doing quite well even from here and should it strengthen, what we will get is a more sustainable leg up in Chinese equities.

Following the recent rally, can you still find value in the market? Can you provide the names of some stocks for which you still see further upside?

While the market (HSCEI) is currently hovering around 15-16x PE, we can find much more opportunities from a bottom up stock-picking approach. Within the portfolio, we still have investments in companies that are still trading at very deep discounts (6-10x PE). At the moment, just looking at our portfolio, we are currently overweight in property in terms of sector allocation. Property has turned the corner, with volume picking up quite aggressively back to the highs of 2007 and we remain bullish on Chinese property developers as we expect housing sales to grow rapidly driven by low interest rates. There has been a lot of under-investment in Chinese property firms and there are still a lot of people that either need a new house or want to upgrade their house. Among the developers we favour are Shimao Property Holdings Ltd., Soho China Ltd. and Shanghai Industrial. Other names that we think remain undervalued include Sichuan Expressway, Dalian Port, Bank of China (Hong Kong), Bank of China and Comba Telecoms.

What are the biggest risks to the economy and stock market that you see from here and how will you change the way the Fund is currently positioned and investment strategy given that some of these stocks have appreciated a lot?

Economic growth may stall if the stimulus policies fail to drive growth on a sustainable basis as was previously thought. Additionally, there could be a short term correction in stock markets over valuation concerns if earnings momentum proves to be unsustainable, although we think that the maximum pullback from here is probably about 10% from current levels.

The Fund has the ability to offer a certain degree of downside protection by:

• Reducing its net market exposure by increasing the cash component (up to 100%) though we have to be mindful of the opportunity cost involved i.e. when markets surge, the Fund’s ability to capture the upside would be limited.

• Making use of derivatives such as put options to reduce downside volatility of the Fund (put protection). For example, we can purchase an index put option to protect a part of the Fund should markets fall significantly. We will consider implementing this strategy when markets move up a fair bit from here and also if market volatility falls, as this will make the cost of protection much cheaper.

Both the economy and stock markets are just in the very early stages of a recovery, as a result we find it hard to anticipate any major domestic issues that could trigger off a huge correction.

Even if stock markets pullback sharply in the near term, we believe that the Fund allows both new and existing investors to participate in the long-term growth story of China knowing that should the need arise, the Fund would be able to utilize certain strategies to reduce the downside volatility.

Taiwan has been one of the best performing markets year to date. Why do you have a short position on the market? Do you have a negative view towards the market?

We have a short position on the Taiwan market because firstly, we are using shorting as a funding source for us to increase our position sizes/ to buy more stocks that we like. The long/short portfolio construction essentially allows us to do is to play on the relative performance between the additional long portfolio and the short portfolio. Therefore it does not really matter whether the short portfolio delivers a positive performance, so long as the additional long portfolio outperforms the short portfolio, this strategy would have already generated additional alpha to the portfolio.

The stocks in Taiwan that we have shorted such as telecom companies have been a very good funding source for the Fund and have contributed quite a bit to the Fund’s outperformance. The other reason is that while on a broader level, the Taiwan market has risen a lot year to date, from an individual stock basis, we have seen the Chinese stocks within our portfolio appreciate much more.

Is the Fund's massive outperformance in recent months a result of its small-mid cap tilt?

The Fund has no fixed investment style. The Fund has had a large cap tilt during inception in January 2008. When markets bottomed in October 2008, we perceived that stocks were excessively undervalued and gradually increased our allocation into small-mid caps, most of which were trading at massive discounts.

The maximum exposure we had to small-mid caps was 30% at that time. This tactical move was one of the contributors to the Fund's outperformance as small-mid caps outperformed the broader market in the current rally. When the small-mid cap stocks have become more fairly valued, we intend to pare back our exposure, it is currently around 25%. We believe that it is our ability and flexibility to switch in between styles depending on what works in the current market that is important. It is this ability that will potentially enable us to create alpha outperformance in any market conditions.

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