City Editor Neil Martin finds Philip Ehrmann, Manager of the Jupiter China Fund, in confident mood
Coping with negative press comments about China has become almost the norm for Philip Ehrmann, Manager of the Jupiter China Fund. He’s become rather used to the sniping about the world’s second largest economy, so he bears one of my first questions about the country with a sense of fortitude and patience. This is especially admirable since he’s just stepped off a plane at 5am that morning, returning from one of the many trips that he and his team make throughout the year to China and Hong Kong.
I’ve decided to warm up by asking him if he has experienced the notorious pollution in Beijing first hand? Actually, he replies, he has usually been lucky: although there was one time in Shanghai last year when you could literally taste the dirt in the air, he has sent many pictures back to his colleagues in London of blue and sunny skies.
In fact, he says, the pollution problem is just one issue where Ehrmann believes that the Chinese Government, far from sitting on high and ignoring the issue, is taking active steps to make things better. He believes it is critical to China’s future and that the leadership “…does get it….” Pollution has become politically unacceptable, he says, and so key performance indicators for local Government employees now include strict environmental measures.
Talking to the Experts
Ehrmann believes in casting his information net wide, and he takes particular care on his travels to speak to not only company management, but others who have influential opinions about how the country is progressing. He recently discussed pollution with a representative of Greenpeace in Beijing and other interested parties who agreed that the authorities were making progress in their attempts to clean up the air.
Yet, typically, the fact that these moves in the right direction do not get picked up in the UK media disappoints Ehrmann. “If you read the press in the UK, you wouldn’t believe that. We’re still getting re-runs of stories about excesses and problems, going back over the last number of years. Okay, there are clearly issues which need to be worked through. China is not a perfect, fully baked economy by any means. It’s changing very rapidly which is both good and bad, but it means you can actually move things quite fast to a more optimum situation.”
Beijing Undersells Itself
He agrees though that the Chinese authorities have not made life easy for themselves: “There is a wonderful industry in terms of knocking China: people have become very good at explaining why one doesn’t want to go anywhere near it, but what I find rather ironic is that the Chinese Government has made something of a rod for its own back by announcing explicit targets for GDP growth, which they’ve been doing for many years now.
“For the last ten years, they were running with an 8% GDP target and if you look at that period, I think compound growth was over 10%. Everyone knew that eight, which in China is a lucky number, meant very little in relation to what the growth was going to be, which in some cases was closer to 12 or 13. In other periods it may have flirted with being just below eight, but it was just a number.
“Now as we look at what’s being going on this year, the fact the Government has set a target of 7.5% GDP growth, and that it might come in at 7.3%, is deemed a crisis for goodness sakes! What is much more important to me is not the quantity of growth, it’s the quality.”
Identifying the Right Fundamentals
Ehrmann says you have to be wary about high levels of GDP: “We try to identify where there are reasonably unique opportunities in terms of management, companies that harness the resources a country might have, or take advantage of a change in pace, a change in gear. That’s really what we look for.
“In the past, China was driven by export-led growth, based on very low cost labour. I did not find this to be of great investment merit. To be honest, low cost labour wasn’t a great selling point because it was going to become higher cost, just as we’ve seen. And you then end up arbitraging away your opportunity to places like Pakistan, or Vietnam, or Cambodia, Bangladesh, which has even lower cost labour.
“So that’s never been something that we’ve focused on too much, rather it’s trying to identify those companies that can either implement and effect change, or capture some of the important imperatives whether it be environment protection, great fuel efficiency, or benefiting from investment in oil and gas, particularly gas exploration. China has a massive job on its hands to reduce its dependence on coal and shift to cleaner fuel sources, and so these thematics begin to build, and you begin to identify blocks of companies and stocks that should have a good chance of capturing those trends.”
Which is Ehrmann’s investment philosophy in a nutshell. It’s all about spotting the themes and pulling it together from there.
Communism and Consumer Power
This leads me onto to one of the great questions about China. Just how will this communist, one-party state cope with the future?
Ehrmann believes that there is massive pressure for the Chinese Government to keep their people on side. The common assumption, he says, is that in a one-party state it this isn’t a problem; but actually it is a major issue. “There are 90 million communist card-carrying members,” he says, “and 1.3 billion people, so you are sitting on top of a powder keg, if you lose control of it, then you’ll ultimately be in trouble.”
The leadership’s big fear is that the people will wake up after 20 years and realise that they are far worse off, and that having no democracy has not served them well. Which is why the Chinese leadership are making it clear that they are listening to people’s aspirations and have set themselves a target of doubling average incomes by 2020. As Ehrmann points out, this is more than just playing to the gallery. It’s telling people what they want to hear, and then having to deliver on it over the coming years.
But there is something more fundamental keeping the Chinese Government alert to the pressures it faces. China has 500 million smartphone users, he says, and just one Chinese company that the fund invests in (the Hong Kong Tencent) has over 400 million active users of its instant messaging service. Which means that pictures, thoughts and reactions can be instantly sent around a huge number of people before the censors can even wake up to the fact that something is wrong. There is indeed censorship in China, he agrees – but “five million people will [still] see something before the censors realise that something is going on.”
Banking and Finance
The banking system continues to need to be refreshed and improved, he agrees, but this is now happening with a recognition of where the old problems lay. “It won’t happen overnight,” he says, “but it’s happening from my perspective, from an investment perspective, over a reasonable time frame.”
The big challenge, he says, is for China to do something to break what he describes as the log-jam of non-performing “zombie loans” made to local governments. Central Government is determined to resolve this issue as part of the extensive reform program announced late last year. It certainly has the headroom to do this, because the combined burden of central and local government debt is estimated to stand at a relatively low 58% of GDP.
In the last few weeks municipal bonds have been launched for local authorities wishing to fund local infrastructure projects such as railways, roads and airports. Previously, the money for such projects had come from banks’ lending on one to three year money, which he says was very inefficient for such large and long term schemes. And the change shows that the central Government is waking up to a new era of sensible financial management and is trying to put the house in order.
As for whether you should have China in a portfolio at the moment, Ehrmann is very frank: “The market is trading at historically low valuations, and all the pessimism that I see and hear, both here and rather frighteningly the short-term-ism out in the region, I think is creating a very good opportunity. Right now it feels very lonely, but I have to say, in an emerging market context that’s always been the way.”
Asked how he markets the fund, Ehrmann agrees that it’s a challenge. “The nature of our industry, particularly at the more retail end of it, is that people tend to wait for direction to be established and performance to be coming through, before they get excited.
“The China story is one that’s just as valid, in fact if anything, I’ve more confidence in what I’m seeing from the bottom up in terms of the quality of companies, some of which are truly becoming world class. We’re not talking about hundreds, we’re talking about a handful of very well run businesses, which are trading at a third, or half of [valuations for] similar companies in the developed world, and exhibiting much more growth potential. I find that a very compelling combination.”
The task of getting that message out there will be aided no doubt by the fact that even though it has not been a great year for investing in China, the fund has performed strongly and relative to its peer group, it grew in size which, as Ehrmann sees it, is quite an achievement.
The Jupiter China Fund, a Luxembourg-registered Unit Trust, aims to achieve long-term capital growth by investing in companies that are based in China and Hong Kong, but also those companies which do significant amounts of business in the region. Launched in 2006, it is currently valued at £164 million, with almost 60 holdings. Main sectors include financials (around 25%), consumer services (16%), industrials (10%), oil and gas (10%) and technology (10%).
Too Much Information
Like many of the senior fund managers we come across, Ehrmann and his team like to kick the tyres, to regularly visit the companies that they invest in. He and his team spend a great deal of time travelling through the region, picking up first-hand knowledge on how industry and the state itself is performing. Ironically, he finds that the fund’s London base is no handicap to this, as in his experience, when he’s had analysts sat in Hong Kong, they got caught up in the daily grind and did no more leg work than the home team sat thousands of miles away.
The major problem he has when picking stocks and deciding on strategy is that nowadays there is too much information. “There is so much noise and information,” he says, “that it’s actually at least as difficult – and arguably maybe more difficult – to make clear and sensible decisions than it was when there was very little information… so in some respects there is a significant information gap with a lot of noise around the edges, so the only way to cut through the noise, is to get out there and do the leg work.”
Ehrmann finishes our talk with a frank comment about investing in emerging markets. It goes like this: “For emerging markets investment, you need to have something of a contrarian approach to life. You do not want to be buying these markets when everyone thinks they are wonderful and they are trading at historic highs. You want to be buying them when nobody wants to be your friend.”
So remember those wise words when you’re thinking of putting emerging markets situations into the portfolio.