Oakmark Funds Thoughts On Volatility In China H-Share Market by Oakmark Funds
In April of this year, several of the firm’s investment professionals traveled to China, Hong Kong, and Macau. This is an interesting period for China, as the country is attempting to transition from an investment and policy-led economy to one that is more reliant on consumption and private enterprise. What made the timing of our trip particularly unusual was the sharp upswing in the Hong Kong stock market. In the first two weeks of April, the Hong Kong market was up 15% on heavy volume. The buying frenzy during this time period was indiscriminate, with 97% of the 460 companies in the Hang Seng Composite Index climbing higher.
The increase in stock prices was due to a combination of relaxed capital restrictions by the securities regulator and the establishment of the Shanghai-Hong Kong Stock Connect. Launched in November 2014, the Shanghai-Hong Kong Stock Connect is a securities trading and clearing program that links the Shanghai and Hong Kong stock exchanges. The program allows Chinese investors to buy shares in Hong Kong-listed companies (H-shares) while also providing foreign investors with access to Chinese-listed companies (A-shares). The Shanghai-Hong Kong Stock Connect represents an important step in the overall liberalization of China’s financial markets.
We think the opening of financial markets is clearly positive. But while this event provides a greater opportunity set to invest in Chinese securities, it is not itself a reason to invest. This distinction is important and often lost on market participants. We have heard these types of comments from various institutions advising clients on how to “play” the rally:
“This rally could continue for at least 15 more days.”
“We believe there will be further relaxation of policy to support the Stock Connect. Overweight China.”
“Buy H-shares with largest valuation discount to A-share counterpart.”
At Harris Associates, we separate ourselves from the day-to-day noise of the stock market. We have no particular insights into how long up or down markets will last and don’t know what policymakers will do. Our efforts are focused on the long-term fundamentals of a business, understanding the motivations of management (including corporate governance, which can be complex in China), and determining the intrinsic value of a company. Our investment decisions are based on the discount/premium the stock is currently trading at versus our estimate of intrinsic value, not relative measures that may lead to a misguided starting point comparison*. As prices in Hong Kong rose sharply, nothing about our investment philosophy and process changed. What did change was the discount of our holdings in Hong Kong as the gap between business value and market prices reduced. We used this opportunity to trim back on select positions.
Overall, we remain optimistic about the long-term prospects of China. There will surely be challenges along the way. However, meaningful structural reforms combined with the buying power of 1.3 billion consumers will continue to be an important economic driver for many companies, whether they are based in China, Hong Kong, or other parts of the world. We will continue to focus on our bottom-up research process to find individual companies that create economic value and sell at attractive prices, while leaving short-term trading strategies to others.
*At the time of this article, the Shanghai Stock exchange trades at a 7-year high and a rich 23x earnings.