Betting on Beijing
Shanghai-based hedge-fund manager Frederic Durr has turned in stellar results by buying smaller companies in markets the government favors.
WHEN HEDGE-FUND MANAGER Frederic Durr launched his Maoming Fund in Shanghai with just $8 million in March 2006, he didn't bother to look at China's best-known companies. He figured that large-caps like PetroChina (PTR) or Industrial and Commercial Bank of China (1398.Hong Kong) already were covered by so many analysts that he'd never find a unique investment angle.
Instead, this opportunistic, value-oriented Swiss investor has recorded strong returns by roaming China's vast mainland in search of lesser-known companies with midsize market caps of $2 billion to $3 billion. He regards them as the true growth story in the world's largest emerging economy, particularly when they operate in markets favored by Communist central planning. After extensive meetings with management, Durr picks companies that can benefit from Beijing's policies that may seek to, say, reduce carbon emissions, develop renewable energy resources or build new infrastructure in the remote cities. He also likes plays on consumer spending, which is growing fast in China.
This equity fund has a long bias because most Chinese midcaps are not liquid enough to short. When the market turns volatile, Maoming―named for a road that runs through a leafy French colonial expatriate enclave of Shanghai―just cashes in some of its stocks. The fund is currently about 15% in cash.
Swiss hedge-fund manager Frederic Durr looks for businesses that will benefit from government policy
"Where we have an edge is in small companies where we have access to management," says the 32-year-old Durr, who's worked as an Asian equity analyst at Merrill Lynch Investment Managers (now BlackRock) in London and at Lloyd George Management in Shanghai. "It's more a question of preserving capital and making a return every year than trying to be clever and short big names in China."
The strategy seems to be working. Maoming delivered a 22.23% annualized return from March 2006 to Sept. 30 this year, according to BarclayHedge, which tracks hedge-fund performance. In contrast, the MSCI China Index, which invests mainly in large-cap stocks, was up 18.19%, and the Barclay Emerging Market Index gained 11.57%. The Standard & Poor's 500 actually lost 0.57%.
Maoming stood out in the crash of 2008, when it gained 14.57% for the year, while the MSCI China Index was down 50.83%. The fund sold Chinese vegetable-wholesaler Chaoda Modern Agriculture (682.HongKong), the beneficiary of a government tax break, at a 39% gain and Australian miner Fortescue Metals Group (FMG.Australia), which exports iron ore to China, at a 29% profit; it also shorted big Chinese stocks like PetroChina and Bank of China (3988.Hong Kong) that were market proxies.
As a result of such moves, the assets of the Maoming Fund, which is registered in the Cayman Islands, have grown nearly nine-fold since its inception to $70 million, according to BarclayHedge. About three-quarters of the fund's assets are concentrated in about 15 publicly listed stocks, and a quarter are in private equity. In addition, Durr and French co-manager Julien Moulin, a former UBS Global Asset Management equity analyst, oversee about $125 million in a special-purpose vehicle that invests in venture capital, giving them a total of $195 million in assets. The two own about a third of Maoming, which recently closed to new investors as inflows rose. It plans to reopen in 2011.
Unlike the nearly 20 other hedge funds that have set up shop in the emerging financial center of Shanghai, Durr avoids the Shanghai Stock Exchange because commissions are too high for foreigners and the environment too much like a "casino," fueled by rumor. So he buys mostly Hong Kong-, New York-, London- and Singapore-listed companies.
Maoming tries to differentiate itself from other hedge funds by making it easy to bail out when the market turns volatile. Investors, the largest of whom are Swiss, are allowed to withdraw their funds during the first year with a 5% penalty. Otherwise, the fund's terms look pretty standard, with a $50,000 minimum investment, a 2% management fee and a 20% performance fee.
One of Durr's better picks thus far was a play on a government policy to promote the use of natural gas and reduce carbon emissions. In August and November 2009, the fund bought ENN Energy Holdings (2688.Hong Kong), a natural-gas supplier, which closed Nov. 5 at HK$24.80 (US$3.20), a 42% gain.
Maoming scored even bigger with a play on domestic consumption, which is outpacing exports as a growth driver of China's economy. It's Lianhua Supermarket Holdings (0980.Hong Kong), a supermarket chain where shoppers pay in advance by buying prepaid debit cards at a discount. The stock has more than doubled.
WHEN HE WANTED TO BET ON the soaring demand for commodities in China, Durr could not find a public Chinese stock that fit Maoming's strategy. As a substitute, he bought Prosperity Resources (PSP.Australia), a mining company that is based in Perth, Australia, and operates copper and gold mines in Indonesia for export to China. The stock has risen 72% on news of encouraging exploration results.
Not every stock in the portfolio is a winner, of course. Take ChinaTel Group (CHTL.OTCBB), which Durr bought for an average of US55 cents between mid-September and mid-November 2009. Since then, the stock is down 82%, following delayed expansion plans, and it traded at 16 cents on Nov. 4 this year. But Durr expects the stock to climb as ChinaTel builds a new WiMAX wireless internet network in 29 cities in China where the company has a license to use fourth-generation cellular technology.
One of Maoming's largest investments is a play on a government policy to develop renewable energy resources. In a private-equity deal that dates back to an initial investment of $2.5 million in start-up capital in 2007, Maoming now owns a 6.8% stake in Envision, a small company that makes wind turbines using proprietary technology and Danish-designed rotor blades in Jiangjin, northwest of Shanghai. Envision's production is increasing thanks to a partnership with Longyuan Wind Power, the largest wind farm developer in China. As Envision readies to go public, which Durr sees sometime in 2011, he expects the initial investment to deliver a return of 400% to 900%.
Although the recent rally is tapering off, Durr is still optimistic for the year ahead. "I don't see the Chinese market collapsing in the near term," he says. "The rest of the world has an interest in China doing well."
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