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China Fund Shows Invesco Sees Transition: Riskless Return

Wang Penghui became China’s top-ranked stock picker by doing what billionaire investor Bill Gross says can’t be done: predict where the world’s second-largest economy is heading.

The manager of the $1.6 billion Invesco Great Wall Domestic Demand Growth Fund (IGWDDGR) has produced the best risk-adjusted returns among 48 Chinese rivals in the BLOOMBERG RISKLESS RETURN RANKING since August 2009. He sidestepped a 40 percent tumble in the Shanghai Composite Index (SHCOMP) by shifting into technology and consumer stocks from the banks and commodity producers that have been hurt most by the nation’s economic slowdown.

While Pacific Investment Management Co.’s Gross said last month that nobody knows what’s in store for China, Wang’s winning wagers show some investors have already anticipated the $9 trillion economy’s transition toward services and consumer spending from the credit-driven construction that propelled growth in the past decade. Companies benefiting from that shift now comprise a record portion of the stock market after service industries’ contribution to gross domestic product overtook manufacturing for the first time.

“China has encountered a bottleneck of the old growth model and we need to walk out,” Wang, 38, said in an interview from Shenzhen, where Chinese leader Deng Xiaoping’s early experiments with capitalism began more than three decades ago. “That’s why we selected industries like technology. They’re necessary for China to transform the structure of its economy.”

People’s Congress

Wang’s top holdings at the end of last year included Leshi Internet Information & Technology (Beijing) Co. (300104), a provider of online videos, and Shenzhen Inovance Technology Co. (300124), which makes products used to automate industrial processes. His fund has also benefited from a bet on BYD Co. (002594), the Warren Buffett-backed maker of batteries and electric cars that more than doubled in Shenzhen trading during the past 12 months.

Those companies are beneficiaries of the ruling Communist Party’s efforts to seek more sustainable sources of economic growth as wages in the world’s most-populous nation rise, pollution increases and debt swells to levels that the Chinese Academy of Social Sciences estimates at 215 percent of GDP. The economic expansion will probably slow to 7.5 percent this year, the weakest pace since 1990, from 7.7 percent in 2013, according to the median estimate in a Bloomberg News survey.

China set a 7.5 percent target for GDP growth for 2014, the same as last year, on the first day of the National People’s Congress. Policy makers may unveil more details of their roadmap for the economy at the annual meeting, which ends on March 13. President Xi Jinping, who took office a year ago, pledged the broadest expansion of economic freedoms since at least the 1990s in November.

Riskless Ranking

The Invesco fund had a risk-adjusted return of 2.1 percent from Aug. 4, 2009 through March 3, the most among 48 China-based equity mutual funds with at least $1 billion of assets, data compiled by Bloomberg show.

Wang’s fund posted a total return of 57 percent in the period, even as the Shanghai Composite lost almost half its value and peers recorded an average decline of about 9 percent. His gains offset above-average volatility to produce a higher ranking than runner-ups Guotai Jinniu Innovative Fund and Harvest Research Selected Equity Fund.

Bloomberg’s risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit risk. The returns aren’t annualized.

Selling Financials

Wang started boosting holdings of technology stocks in the second half of 2012, with positions in the industry reaching about 37 percent of the Invesco fund by last year’s second quarter, the most recent period when full holdings data were available. His weighting in consumer-discretionary stocks, including automakers, reached 33 percent, data compiled by Bloomberg show.

At the same time, he liquidated holdings in financial companies and reduced raw materials to less than 1 percent of the fund, the data show. The two industries make up about 45 percent of China’s CSI 300 Index, even after valuations of financial shares in the gauge reached a record low last month.

“The outlook for traditional industries is very unclear and the best strategy is to avoid them,” said Wang, whose firm, Invesco Great Wall Fund Management Co., is a venture between Atlanta-based Invesco Ltd. and Shenzhen-based Great Wall Securities Co. “Though their valuations are low, the outlook is complicated with overcapacity and poor demand.”

Mystery Meat

The money manager said he gets insight on the economy by talking with executives at the companies he owns, including Shenzhen Inovance Technology, which surged 144 percent in 2013 and has gained another 30 percent this year.

“The company touches lots of downstream industries,” he said. “We ask them what the economy is like and they give us lots of clues.”

For Gross, who oversees about $1.9 trillion as the chief investment officer at Pimco in Newport Beach, California, China’s opaque economy makes it a “wild card” for investors.

“I call China the mystery meat of emerging-market countries,” he said in an interview on Bloomberg Television’s “Market Makers” with Erik Schatzker and Stephanie Ruhle on Feb. 4. “Nobody knows what’s there.”

A smooth transition for China’s economy may get derailed by bad debts. Soured loans at the nation’s banks have increased for nine straight quarters to 592.1 billion yuan ($96.4 billion), the highest level since September 2008 and about 1 percent of total lending, according to the China Banking Regulatory Commission. Gross has drawn parallels between the situation in China now and that in the U.S. before the 2008 financial crisis.

Valuation Risk

The beneficiaries of China’s transition have become riskier bets after their stock-market valuations increased, said Wang, who pared holdings of technology companies and some consumer-related shares, including BYD, during the past few months.

The CSI 300 Information Technology Index trades at 4.1 times net assets after jumping 33 percent during the last 12 months, almost three times more expensive than the Shanghai Composite, which fell 8.9 percent during the period, data compiled by Bloomberg show. The combined market value of technology, health-care, telecommunications and consumer companies in the CSI 300 increased to the highest level since at least 2007 versus the broader index last week.

BYD trades for 69 times estimated earnings for the next 12 months, compared with an average multiple of 14 for global peers tracked by Bloomberg.

PBOC Help

“Investors usually ignore risks and have good expectations in a time of an inflection point of the economic transformation,” Wang said. “The overall valuations of technology stocks are expensive and are developing a trend of bubbles.”

Wang still sees rising odds of a successful economic transition as more policy makers, business leaders and other Chinese citizens begin to recognize the benefits.

China’s cabinet, which approved a plan in May 2012 to boost seven “strategic” industries including technology, said last August the government will increase Internet access and build faster wireless networks to spur growth. The People’s Bank of China said in January it will aid technology companies seeking to go public and make acquisitions.

Services industries accounted for 46.1 percent of the economy last year, with the proportion exceeding that of manufacturing industries for the first time, according to the statistics bureau. The government is seeking to increase the share to 47 percent by 2015, according to its five-year plan. In the U.S., the world’s biggest economy, services comprise about 90 percent of GDP.

“People have realized the benefits of the transformation and have been acting accordingly to help that,” Wang said. “The possibility of success is increasing.”

To contact Bloomberg News staff for this story: Zhang Shidong in Shanghai at szhang5@bloomberg.net

To contact the editor responsible for this story: Michael Patterson at mpatterson10@bloomberg.net

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