Dynasty Asset Management Ltd was established by Steve Dai
and Edward Mullen in 2000. The firm is one of the earliest
alternative investment managers to set up operations in Shanghai.
It manages two funds - the Dynasty Fund and the Dynasty China
Opportunities Fund. The former has generated average annual
returns of 38.5% since inception (February 2001) and -4.72%
year-to-date, while the latter was launched this year and
has generated returns of -2.72% since January.
There are now around 25 Greater China focused hedge
funds; that is up from five funds two years ago. Do you
believe that the space is becoming too crowded and that
returns for all funds will suffer?
The number of hedge funds specialising in China-related
securities has grown multi-fold over the past few years
as you correctly point out, particularly after a strong
2003 for the markets, many new "experts" have
emerged. This is true of China-dedicated funds, Asia long/short
funds, as well as large macro funds and traders from other
global strategies who see the opportunities in China,
and are trying to capitalise on them. For Dynasty, we
view this as a positive development for our markets and
our firm. Liquidity in the markets has grown substantially,
investor awareness for the region has also grown, and
we believe that the more education that exists about the
opportunities and pitfalls of the market, the better it
is for everyone. Ultimately, more opportunities will be
explored, rather than the space becoming too crowded.
- Has the ability to short borrow individual names
in the Hong Kong H share and Taiwanese markets improved
Yes, and conditions continue to improve overall. In fact,
total turnover increased 64% in the Hong Kong market in
the past year. While shorting stocks is still more challenging
in Asia than in other markets, like the US for example,
continued increases in liquidity have made it easier.
Do you envision that going forward (and, of course,
depending on market conditions) hedge fund managers running
Greater China funds will actively short individual names
instead of using index futures as a hedge?
Not as extensively as in the more developed markets.
Shorting stocks takes great research and diligence, and
many firms do not have the abilities or resources to effectively
place shorts and monitor them. Due to these as well as
because of liquidity constraints, using index futures
is also an efficient method to hedge market risks. While
there remain extraordinary opportunities on the long side,
there are some companies doing business in China or trying
to do business in China that will fail. There are also
several names that exist now and will emerge in the coming
years that will be overbought by overzealous China-philes,
which will subsequently come tumbling down. As a long/short
manager based in China and actively trading the markets
for the past nearly four years, this plays to our strength.
I expect that going forward both methods will still be
very active for hedge funds.
- Do you think that property in China, specifically
in Shanghai, will have a correction over the next 12 months?
If this correction occurs, how will it play out in the equity
I do expect the property price in China to experience
a correction over the next 12 months. The China property
bubble is driven largely by foreign fund investment and
speculation, rather than by the true demand of local residents.
A few factors will likely bring pricing back into line:
First - an interest rate hike. This has reinforced the
market's expectation of easing measures, which increases
speculation on property. However, I expect the Chinese
government to maintain tightening measures, including
an interest rate hike. A significant increase in interest
rates will not only affect residential affordability,
but also affect capital outflow, both being negative to
the property sector.
Second - demand cannot keep up with supply. The property
supply is overwhelming the demand for property. The supply
of new properties is rising at 20-30% per annum, while
the Chinese household income is not increasing nearly
as fast. The RMB deposit growth rate has been slowing
down since the beginning of this year, which indicates
that there will be less money for mortgage loans for property
development. In this case, continuous property supply
will lead to a drop in property prices.
As for the impact on the equity markets, a fall in property
prices could dampen stock investors' confidence in the
markets, which has the potential to cap the upside of
the equity markets.
- In September at the Communist Party of China's 16th
Central Committee Meetings, Jiang Zemin resigned as chairman
of the Central Military Commission and was replaced by Hu
Jintao, President and General Secretary of China's Communist
Party. President Hu now controls all three of China's most
powerful offices. Many in the media see this as a "push-out"
of Jiang Zemin and the old guard and a solidification of
power for Hu Jintao and the "reformers." What
are your views on the political events in September and
how they will affect economic and political reforms?
Since Steve and I started Dynasty, I have always told
investors that the greatest risk to the long portion of
our portfolios is significant political instability in
China. That said, I then share with investors that over
the years, the political situation in China has gotten
far better and more stable than ever before. The "power
transfer" in September, I believe, has improved the
political landscape in China and strengthens the central
government control, which can help the Chinese economy
maintain stability. It is one of many very good signs
about the future of China's markets and economy, particularly
for foreign investment.
There appears to be a massive amount of IPOs (estimated
around US $20 billion) slated to be issued from Chinese
companies next year; the three mega banks being the largest.
Intuitively, this increase in supply and especially concerns
over its quality should have a negative impact on the
market. Are you concerned; and if not, what opportunities
do you see for next year?
In 2005, it is estimated that the dollar value of Chinese
companies going through an IPO in the Hong Kong market
will amount to US$20.3 billion. I am certainly concerned
about the quality of some of these companies. This liquidity
and financing opportunity for Chinese companies will be
very important for them to maintain competitiveness in
an increasingly competitive market. It will also, however,
allow companies that do not merit existence to stick around
with the help of the market momentum and frenzy for Chinese
IPO shares. Comprehensive fundamental analysis using a
top-down approach is one of the key means by which Dynasty
tries to sort the high quality from the poor quality companies.
We invest significant resources in research within mainland
China to understand company fundamentals and consumer
demands and desires. Some of the likely IPO companies
are expected to be in up-stream industries in China, such
as in the coal, port and power sectors, which we favour
for both the short and long run.
- There has been much talk since April of China navigating
between "soft" and "hard" landings;
but we have rarely seen an explanation of what constitutes
a "soft landing" in the context of China's economy.
What is your definition of "soft landing," and
has it been achieved?
In my view, a "soft landing" should lead the
Chinese economy to tone down its growth rate modestly,
i.e., the growth rate of GDP will slow down, but stay
above 7.5%. It is too early to say if China has achieved
a hard landing or soft landing because some uncertainties
still exist for the outlook of the Chinese economy. This
depends on two factors. One is the property market in
China. The uncontrollable nature of the property bubble
increases the risk of a hard landing. Second is the pace
at which the Chinese central bank (PBOC) and US Fed will
raise interest rates. In this case, there are two scenarios:
The worst-case scenario is the Fed goes on to raise interest
rates, while China does not. This will result in massive
cash outflows from China and make a hard landing more
likely. The best-case scenario is the Chinese government
raises interest rates following the Fed, which we believe
will increase the chance of a soft landing.
- What is your 12-month view on Chinese interest rates
and any possible re-evaluation of the Chinese Renminbi?
Can the Chinese Central Bank raise interest rates while
maintaining the currency peg? How would a rise in rates
affect Chinese equities?
I think China will need to raise interest rates given
current US rates. The PBOC needs to squeeze out excessive
and inefficient investment capacity via an interest rate
hike. If this does not occur, it will not only result
in more financial losses to the banking sector, but will
likely also result in a mass exodus of capital outflow
like we witnessed during 1998-2000.
It is very possible that we will see a revaluation of
the Chinese RMB. The Chinese government's failure to revalue
would put further pressure on the cost of importing oil.
Recently at least two Chinese officials have gone on public
record stating that appreciation of the RMB will not negatively
impact the Chinese economy or employment. I view this
statement as a sign that RMB revaluation is likely, and
believe that the actual result will be a widening of the
foreign exchange floating range.
A currency revaluation would likely boost market liquidity,
especially for Hong Kong listed equities. Dynasty monitors
this closely, and we are very ready to take advantage
of this investment opportunity.
- You mentioned in your September monthly newsletter
the managers increased the funds' exposure to the commodity,
oil, power and sea transportation sectors. Has this re-allocation
been successful and what are your sector views going forward?
Yes, it has been successful. The portfolio return of
Dynasty Fund was +2.17% and Dynasty China Opportunities
Fund was +2.87%.
Going forward, we favour oil & petrochemical, retail,
insurance, toll road, power and port industries.
My personal comments
In my view, to understand the current Chinese economy one
needs to understand what caused the investment boom. I think
the two most important factors are exports and capital inflow.
Chinese exports are driven by global consumption, especially
consumption coming from European countries and the US. The
capital inflow into China is caused by the low interest rates
in the US. Therefore, the level of US consumption and level
of the Fed interest rate will both be instrumental in determining
the extent of the Chinese investment boom, and in turn, the
Nowadays, the Chinese financial/banking sectors are not able
to accurately price investment risks. In order to avoid an
investment bubble, China needs to reform its financial system
and make it more market-based. This is likely to happen as
three of the major banks are floated and additional joint
ventures with western financial institutions occur.
Looking on the bright side, the industrialisation and modernisation
of China will continue for a long time. In the near future,
the economy may suffer some pain. But the economic cycle is
and will always be comprised of ups and downs. The best way
to play China is to accumulate cash on the peaks and invest
at the troughs. Dynasty has been profiting from this investment
strategy for nearly four years, and we intend to do so for
many, many years to come.
Dynasty Asset Management Ltd
+86 21 6340 4400