What China Share Rally? Best-Performing China Fund Expects More

China’s shares are at a seven-year high and Blackstone Group LP is warning of stock-market excess. The manager of the best-performing long-only fund investing in the nation’s equities disagrees and says there’s more to come.

The Chinese equity market will more than double over the next three to five years amid low interest rates and a restructuring of the corporate sector, according to Wong Kok Hoi, founder and chief investment officer of Singapore-based APS Asset Management Pte. The $3.1 billion APS China A Share Fund and related accounts under the same strategy returned 33 percent after fees this year to April 17, beating 21 other long-only funds investing in Greater China tracked by Eurekahedge Pte.

“If earnings continue to grow at double-digit rates, real interest rates continue to decline, liquidity continues to be abundant and the government continues with its reforms and corporate restructuring, then I wouldn’t be surprised if the price-earnings ratio would be as much as 35 times,” Wong said in an interview April 21. “I expect that scenario to happen.”

Steve Schwarzman, Blackstone’s co-founder and chief executive officer, said this week the Chinese stock market shows signs of excess as the population plows savings into it while economic growth slows. The Shanghai Composite Index has increased 36 percent this year, making it the world’s second-best performing benchmark gauge, and is currently trading at 17.8 times estimated earnings for the next 12 months.

Orderly Rise

The rally has been fueled by cuts in interest rates and government stimuli as Premier Li Keqiang vows to prop up an economy that expanded last year at the slowest pace since 1990. The People’s Bank of China this week cut the proportion of deposits banks need to set aside as reserves.

“The government hopes to see an orderly, moderate rise in the stock market over many years,” Wong said. “It doesn’t want the market to rise sharply in a short period of time. Nor does it wish the bull market to end any time soon.”

APS oversees $3.8 billion of assets. Its second-biggest investment pool, the long-short $380 million APS Asia-Pacific Hedge Fund, has returned a net 25 percent this year through April 17.

Given the outlook of low interest rates and rising corporate earnings, stocks are “still undervalued,” Wong said.

The Shanghai Composite index’s price ratio of 17.8 times estimated earnings for the next 12 months compares with a 10-year average of 15.6 and a five-year average of 11.1, according to data compiled by Bloomberg. The index gained 2.4 percent on Wednesday and closed at 4,398.5, the highest since March 2008.

Banks Overvalued

China’s stocks fell the most in almost seven weeks on April 20 after regulators banned the margin-trading businesses of brokerages from using so-called umbrella trusts and allowed fund managers to lend shares to short sellers. Shorting involves selling borrowed stocks in anticipation of buying them back for a profit when their prices fall.

Wong said he’s cautious about bank stocks. Lenders’ nonperforming loans rose to 842.6 billion yuan ($136 billion) by the end of December, the highest since 2008, according to the China Banking Regulatory Commission

“Banks are overvalued because of the problem of non-performing loans,” Wong said, declining to say what the biggest holdings are for his funds. “That issue hasn’t been addressed by either the banks themselves or the government.”

Small capitalization stocks, whose prices have as much as tripled, will see a major correction “in the years ahead,” said Wong, who worked for Singapore’s sovereign wealth fund GIC Pte from 1981 until 1985.

The ChiNext Index of Chinese small cap stocks has surged about 270 percent since the beginning of 2013, compared with a gain of 94 percent gain in the Shanghai Composite.

Founded in 1995, APS serves institutional investors such as pension funds, endowments, foundations, family offices, funds of funds, and sovereign wealth funds, Wong said. More than half of the investors are based in North America, with the remainder evenly split between Asia, Europe and Australia, he said.

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