Angus Tulloch of First State talks to Merryn Somerset Webb about China, why he favours stocks over other investments right now, and fund management fees.
Merryn Somerset Webb: You’re seen as a China bear, but you come across as more cautious than bearish.
Angus Tulloch: China is like the rest of the world, but in extremis. It’s pumped in $1.5trn in stimulus. The question is whether it can get off that treadmill. There could be some nasty medium-term side-effects. Domestic consumption has held up, but still in 2009 something like 90% of the growth related to fixed-asset infrastructure came from government.
Merryn: Is this infrastructure needed?
Angus: Some say China has one-fifth of the rivers of the US, but twice as many bridges. There are probably some daft projects going on, but at the same time I think the rail programme makes real sense. People underestimate the social benefits of railways.
Merryn: What of the ghost towns?
Angus: There are definitely a lot of empty properties, often being held simply because the return on cash is so low – under 2% on deposit.
Merryn: That’s the case everywhere. But it’s not stimulating other property bubbles.
Angus: You’ve also had quite a strong stockmarket in China and now some quite strong cost pressures, such as wages. In one place the minimum wage has gone up well into double digits and people are talking about wages going up in China by about 10%.
Merryn: But this is a good thing, right? It might be bad for inflation numbers, but surely we should all be thrilled to see living standards rising?
Angus: But can governments control all this money as well as people seem to think? The Chinese have succeeded so far, but no one else has got away with it.
Merryn: What makes you think they can’t?
Angus: History more than anything else. An old-fashioned belief that, if you print money, at some stage people suddenly ask what it’s really worth. Then you get frenzied buying – as in Shanghai in the late 1940s. Then inflation suddenly picks up. That was a factor in Tiananmen Square: inflation was quite high so the students had support from the workers and it all spread more than it might have done. There is a strong link between rising inflation and social unrest.
Merryn: Inflation in China is already rising.
Angus: The official figures are about 3% and the real figures, I would say, at least 5%. One thing we’re looking at quite closely for signs of panic buying is gold sales in China. No sign yet, although gold sales have been strong in Hong Kong.
Merryn: If you did see raised buying of gold in China, what would you do?
Angus: We’d expect the government to move quickly and raise rates. That wouldn’t be good for the stock or property markets. But we’re pretty well positioned for it. We only have 1% in infrastructure stocks in China. You’ve got to avoid industries where prices are likely to be controlled by the government – power firms would be the classic example. The 1% is mainly in China Resources. We think it’s an exceptional company and its merits more than compensate for the likes of this happening.
Merryn: Do you worry about inflation in the West?
Angus: It’s less of a problem – it doesn’t have capacity issues in the short term.
Merryn: But China doesn’t actually have any capacity issues either. The factories that China has built to supply America aren’t working.
Angus: I think six months ago there was a big overcapacity problem. But while there are parts of, say, the steel industry where it’s still an issue, there are other areas – for instance auto manufacture – where it isn’t.
Merryn: But a double dip in the US could change that fast.
Angus: Yes. The only thing is that China exports necessities to the US. So it’s probably not as sensitive to recession as the firms that export goods from Germany and the US to China. But I agree that a global double dip, which might well be led by China, is something that can’t be removed from the equation.
Merryn: You sound quite bearish to me.
Angus: In the sense that I don’t think these risks have been factored into share prices. On the other hand, the alternatives to being invested in equities are unattractive. So if you can find a cash-generating franchise that gives you some protection against inflation, it’s probably a better bet than cash – except if you have a sudden sharp sell-off.
Merryn: So even right now, if a punter comes along with £50,000 and says he’s either keeping it in cash or putting it in a China fund, you’d still say take the fund?
Angus: Well, first I’d say I’m not qualified to give advice, and second I would have some cash, but the majority I would put in equities.
Merryn: But in Eastern equities? If you had to make a choice…
Angus: If you’re taking a long-term view.
Merryn: What’s long term?
Angus: Anything over five years.
Merryn: On a less than five-year view?
Angus: It depends on your circumstances.
Merryn: Surely the question is simply which area is more likely to outperform cash over the next five years? It doesn’t matter what your circumstances are.
Angus: It matters what your currency is because your obligations are going to be in sterling.
Merryn: OK, our punter’s obligations are in sterling.
Angus: I’d expect most currencies to appreciate against sterling because in the end Western governments will inflate themselves out of their problems.
Merryn: But sterling’s already fallen 30%.
Angus: I don’t think things are desperately cheap here.
Merryn: So it’s the opposite of what we’ve had for the last decade. We’ve been importing deflation from China, but now, with their costs rising and our currency falling, we will be importing inflation?
Angus: It’s certainly a possibility. But still I think if you focus on stock selection and price, you’re better off in equities. There’s no point in being too bearish about them as an asset class.
Merryn: Are there enough suitable stocks?
Angus: In Asia there are.
Merryn: You aren’t very heavily invested in India.
Angus: That’s purely about price. We love Indian firms and think they’ll cope with the international scenario, partly because they’re more familiar with the global culture than a lot of Chinese managements. Managements in India are so enthusiastic and a lot of them are visionary and can articulate ideas very well. With a Chinese management you have, in so far as one can generalise, almost to drag the good news out. In India you have to slightly discount the good news you get. We bought some Tata Power recently. The outlook for the power industry in India is very promising. They are having shortages already and that’s the time to invest.
Merryn: And Australia?
Angus: In Australia you know that you won’t be hit by too many taxes and royalties or confiscations. So there our resource exposure is almost entirely in the form of gold firm New Crest. Given the extent to which governments are printing money, we feel you ought to have 10% of your portfolio in something gold-related. We also have a couple of gas holdings, Woodside and Oil Search. Otherwise our holdings there are stock-specific.
Merryn: How often do you go to Asia and are you tempted to move?
Angus: Probably four to six weeks a year and no – I lived in Hong Kong for three and a half years and I met my wife there. It was a fantastic place to work. Because you tend to be in a branch office, you get more responsibility earlier. That’s what gave me the taste for Asia’s potential.
Merryn: I wanted to ask you about fees. You have two Asia Pacific Funds, one has a 1.5% management fee (the Asia Pacific Leaders Fund) and one a 1.75% management fee (Asia Pacific Fund). If you look at the top stocks, they are roughly the same. So what makes one more valuable than the other?
Angus: You can only invest so much in smaller companies, or you have capacity problems. So when the money keeps flowing in, as it did with the Asia Pacific Fund, what do you do? Just carry on taking money? Or close it, which we did five or six years ago? You can imagine that was one hell of a battle with our sales team. The other product, Leaders, just doesn’t invest in companies under $1.5bn, so it can grow much bigger.
Merryn: That still doesn’t explain the difference between the management fees.
Angus: Most people, if they could come in, would like to have the all-cap product. They would put a higher premium on it. It is also more labour-intensive – 120 holdings rather than 60 in the Leaders.
Merryn. Even with your performance, 1.75% does seem high…
Angus: If you look at our performance and compare it with hedge-fund strategies, it’s consistently better. So I agree, it’s not the bottom of the range – but we feel that…
Merryn: That it’s worth it?
Angus: It’s worth it, yes.
• Angus Tulloch is Joint Managing Partner of the Asia Pacific/Global Emerging Markets equity team at First State Investments. He has more than 30 years’ market experience and has a long history of excellent performance: according to Trustnet, the annualised total return of funds under his management has been 13.7%. Over the last five years he’s returned 146%: his peers have averaged 106%.