Up close and personal is the secret of Maoming’s success
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June 2009 Newsletter
Detailed knowledge of the Chinese story is vital for Frederic Durr and Julien Moulin, which means they must operate like private equity investors in their approach to company research.
Hedge fund managers can debate endlessly about the relative merits of being close to or far from the markets they invest in. For the founders of Maoming Investments though, there was no doubt that proximity to the market was what would give them an edge. So far, they are right. As of 15 June 2009 the fund has achieved a return of 10.6% for the year and an average annualised performance of 23%.
The Maoming Fund focuses exclusively on China plays and overseas companies that are totally reliant on China. The only way to counteract investor unease about the quality of information they were getting about China from the outside was to be based at the heart of China’s economic development, in Shanghai, says Julien Moulin, who together with Frederic Durr co-founded Maoming. Both have lived there since 2004. Before the fund launched in February 2006, Durr and Moulin were joined by Ivan Qi, who was born in Shanghai and came back to China towards the end of 1998.
Location is key to the fund’s philosophy. “It’s very hands-on, we do a lot of ground-level research,” says Moulin. “We are value-driven, very fundamental – and the big difference is we can visit companies easily.”
Not that this makes the process of extracting information easy. Without the more sophisticated valuation models available to Europe and US-based managers, the Maoming team have taken an approach that is similar to private equity investing.
“The most frustrating part is when you go to meetings and not get anything out of them,” says Moulin. “In a one-hour meeting with the CEO of Vodafone in the UK you get a pretty good
understanding of the answers to your questions. In China you get information on the second or third meeting, and to get to the real information takes a lot of time. On the other hand, people are not as sophisticated as European and American companies and they tend to give you more information than they should. Then you have to cross-check the information you get from the companies at many different levels, with customers, suppliers, regulators, government officials. To do that from outside China is very time-consuming.”
Launching the fund in early 2006 should have given Maoming a head start, but Julien Moulin recalls that they put their money to work in April ahead of a big sell-off in the market and had to work hard to recover performance for the year. In 2007, when everyone was making money, the challenge was to try and pre-empt the downturn that was going to follow the bubble. “In 2007 everyone was making money, then from the beginning of 2008 we were telling our investors that most people investing in China really don’t know how to manage the downside and be conservative,” says Julien Moulin. “We thought they would leverage on the way up but also on the way down, and that’s what happened.”
By January 2008 the Maoming Fund was 35% to 40% in cash, and focused on sectors in which the team had high confidence, such as iron ore and agriculture. These sectors did extremely well in the first half of 2008. With the extreme winter that year, the price of fruit and vegetables rocketed, and the fund was able to play this through stocks such as Chaoda Modern Agriculture and China Green. Iron ore was played mainly through three Australian companies selling exclusively to China.
“We went to talk to some large iron ore and steel traders who were telling us they were not expecting a price increase in iron ore contracts signed between Brazil and Australia on one side and Japan and China on the other. We thought there would be a positive surprise in the first half of 2008 and there was, so we did well until May, then we took a profit,” explains Julien Moulin.
The fund also looked to increase liquidity. “In 2006 and 2007 we had some priority investments in small- and mid-caps, but when we started to see the overall deterioration of the economy, we switched to larger names, and given the size of the fund, it was not difficult to get out,” says Moulin. The fund’s turnover also increased sharply, from around 25% in 2006 and 2007 to 150% to 160% in 2008.
“We started to be much more nimble in the second half of 2008. We knew a lot of larger funds were facing redemptions, and they were so big they owned almost every stock. So when these funds had to sell their positions we knew it would have a massive impact on the stock price. We were able to benefit from the subsequent technical rebound and we bought in at that point.”
Being close to the market helped Maoming to identify shifts in the banking industry that protected them from losses on the real estate sector. In May of last year banks were still not lending to real estate developers and at the same time a lot of property development projects were coming across the teams’ desk. Property agents were reporting stagnant transactions while real estate developers were asking for investment and offering 40% interest.
“When we started to look at real estate developers the valuations were still high in May and June, but the cost of borrow on single stocks was extremely high. Since we could not find the right investment vehicle to play to fully reflect our view, we decided not to take the risk,” says Julien Moulin.
“This is still one of the big issues here if you want to run a proper long/short equity fund, is that it’s difficult to hedge your portfolio. If you want to short, the 120 largest names on the Stock Exchange of Hong Kong are all skewed towards commodities, banking, telecoms and insurance. We don’t want to take the risk of a mismatch in our portfolio and we shorted only three times last year, and used cash to cover our market exposure. At some points in September and part of October, we were close to 60% cash. At the highest point we were 60% cash, 12% short, and 28% long, giving 16% net exposure, which is pretty conservative.”
By November and December the fund started to get into domestic real estate names on the long side as banking sources were telling the Maoming team that the government had given them the green light to lend to real estate developers and individuals to buy housing. Valuation-wise, most real estate plays were trading at a 75% to 95% discount to net asset value.
“The news flow was extremely negative, short-selling quite high and all that was needed was a slight improvement to get a huge run. We put 20% of the fund in five large real estate developers and decided to get in towards the middle of November. Our timing was quite good, and we made a killing on those five names,” says Julien Moulin.
The fund has a tight focus, typically investing in just 15 to 25 names. Ideas are generated through weekly valuation screens which yield anywhere between 20 and 150 names to investigate. “We are not big believers in a diversified portfolio. You can’t generate hundreds of ideas a year, and it becomes extremely time-consuming to monitor a big portfolio,” says Moulin. “Corporate governance and communication with investors is done differently here. You can’t expect regular phone calls to keep you posted on what’s going on.”
In the first years of the company, a lot of time was spent seeing companies and gaining an understanding of the overall competitive environment by talking to listed competitors, regulatory bodies, and clients to see if the information from the company was confirmed by other market participants. “From July 2004 to February 2005 we didn’t put any money to work, we just spent time visiting companies. This was particularly important for me because Frederic knew some of the companies but for me China was a new market,” says Moulin. “We did the legwork in 2006 and 2007 with company visits, now we go on an as-needed basis.”
The team avoids companies that it does not have a clear understanding of, and rarely invests in companies with a low return on equity, such as auto parts and airlines. Although the fund has no fixed sectors, in reality it rarely invests in biotech, IT or technology because of difficulties in predicting cash flow. “Typically we’re trading in retail, consumer goods, renewable energy, commodities, energy-related stocks, services such as telecoms and logistics, and we also invest in some medical equipment manufacturers,” explains Julien Moulin.
Positions are usually sized at 4% of the portfolio, sometimes at 8%, though occasionally ideas are allowed to run up to 12% of the total. The amount of time spent researching companies
becomes a form of risk management in itself, and the fund only has soft stop-losses. “We take another look at the investment rationale if there is a big drop in the share price, but if there is no change in our rationale, we might take advantage of a drop to add to our position,” says Julien Moulin.
There are plenty of interesting opportunities ahead for China funds, says Moulin, but in the immediate future there is cause for concern, and the fund is currently slowly increasing its cash position. “In the recent rally there was quite a lot of rising expectations, a bigger trading volume in the Hong Kong market, a significant improvement in investor confidence, and as a result a lot of institutional investors sitting on cash had no choice but to participate in the rally,” says Moulin. “This was confirmed by a Merrill Lynch survey which said that 60% of managers were overweight China. So where do we go from here?”
Although the China economy has been pretty resilient so far, this is now well known by the market and reflected in earnings generated by most companies. With stocks in the main indices overbought, Moulin sees a potential for a sell-off if earnings do not meet expectations.
“Given our discussion with companies, and anecdotally, we don’t see any sign of an across-the-board surge in corporate profits so we decided to slowly increase our cash position and focus on names with higher visibility on the books and good growth prospects, on the back of big trends determined by the government,” he says.
But given that China continues to be the only major economy that is still growing, with one of the world’s strongest balance sheets and little household debt, that cash position will stand Maoming in good stead when the time is right to buy back in again.
FREDERIC DURR: CV Eight years’ experience investing in Greater China Current: Partner and fund manager at Maoming IM 2005-2008: Portfolio manager of the Global China Fund Previous experience: Analyst at Lloyd George, Dalton and Merrill Lynch
JULIEN MOULIN: CV Five years’ experience investing in Greater China. Current: Partner and fund manager at Maoming IM 2005-2008: Portfolio manager of the Global China Fund Previous experience: Analyst for UBS Global AM and Investment manager at Axis Capital
MAOMING FUND: AT A GLANCE Inception Date: Mar 2006 Managers: Federic Durr, Julien Mouli Offices: George Town, Cayman Islands Strategy: Chinese Equity Assets in Strategy: $32 million Administrator: HSBC Securities Services Prime broker: None Minimum Investment: $50,000
Open to investment: Yes
2009 HedgeFund Intelligence Ltd