Staying the Course

Bin Shi has lost a lot of sleep lately. And it’s not just because the 31-year-old portfolio manager is the proud father of a 4-month-old girl.

As the manager of U.S. Global Investors’ China Region Opportunity Fund, Shi has spent more than a few sleepless nights monitoring the stock market movements caused by the currency meltdowns in Southeast Asia and the ongoing struggles of the Japanese and South Korean economies.

But after close consideration of the economies of China and Hong Kong, the Shanghai-born former banker has stayed with stocks of those markets, convinced that the greater-China region will remain a good place to make money.

Sticking to that conviction, however, has meant some pain in the near term. Shi’s $42-million fund, like others investing in the region, has lost value in recent months, and slumped sharply last week. Still, Shi’s fund led Lipper Analytical’s China-region funds category in 12-month return through Sept. 30, with a 39% gain. Year to date, the fund is up 8.5%.

Shi, a graduate of Fudan University in Shanghai, has managed the China Region fund since November 1995. He also is in charge of U.S. Global’s U.S. All American Equity Fund.

Shi is based in San Antonio, home of U.S. Global, which manages approximately $1.5 billion in total. He was interviewed by Times business reporter Evelyn Iritani.

Times: Tell us a bit about your investment philosophy.

Shi: Since the fund was started [in 1994], we have mainly focused on mainland China and Hong Kong, because we feel mainland China is going to serve as a growth engine for the entire Southeast Asia region.

I have a few stocks in Taiwan and a few stocks in South Korea, but I’ll say that between Hong Kong and China, it’s about a 50-50 split for the rest of the portfolio.

Times: Will you continue that focus?

Shi: I wanted to invest all my stocks, all my money, in Chinese companies, but not all Chinese companies are up to the quality of Hong Kong companies and multinational companies. One shouldn’t be blatantly bullish about China, because once you do that, you overlook problems that you know exist in every economy. China will have a great future, but not every Chinese company can capitalize on it.

Times: How do you evaluate Chinese companies?

Shi: First, I look for companies that have an expanding profit margin. Either they are in a pretty good business, like the service industry, or they have monopoly status so that a competitor would not be able to enter their field very quickly or without a huge initial start-up cost.

I also look at the price-to-earnings ratio and price-to-book to see if they’re within my range. And third, I want to find very entrepreneurial, quality managers who have proven that they are able to compete in a free market.

Times: Where do you get your information?

Shi: As you know, in terms of quality of disclosure and quality of numbers, Chinese companies are not as good as Hong Kong companies and U.S. companies. That’s a pretty well-known fact. But an investor can do a lot of homework. You can talk to their competitors. You can talk to the people who are actually working in the company, and you can talk to analysts or other people inside the industry who track those companies on a daily basis.

Times: I understand you travel to China four or five times a year. Do you have good contacts there?

Shi: Because I went to college in China, I have some friends working in the securities industry, and a lot of times by talking to them I can get a valuable perspective.

Times: What are some of the different ways you can invest in the region?

Shi: One is to buy Hong Kong companies. Obviously, a lot of my competing funds are getting China exposure by doing this.

You can invest in Chinese stocks directly through “red chips” [Hong Kong-based companies tied to mainland enterprises] and . . B shares listed in China [B shares are specifically for foreigners]. There also are N shares, which are Chinese companies listed on the New York Stock Exchange.

Times: Give an example or two of some of your favorite China-related stocks.

Shi: There are several companies that have done really well for me. One company is Guangdong Kelon Electrical Holdings . . . , the largest refrigerator maker in China.

By being the No. 1 refrigerator maker in China, they can achieve economies of scale, and they’re able to sell their products at a very competitive price. They can still make a 30% profit [margin] even while their competitors are losing money. They have sources to get parts locally, which is a cost savings. They are starting to develop their own product-development center. And they spend close to $100 million every year to hire Leo Burnett as an ad agency to make commercials for them in China and in Hong Kong. That’s very unusual for a Chinese company.

The company is trading around 18 times earnings, and the first half of this year its growth was 50%. With the industry going through a consolidation, they will be able to take over some weaker competitors to expand their production capacity. One of the problems they have is they can’t produce enough to meet all the orders they receive. . . . Right now [their market share is] is about 17%.

Times: Do they have any major foreign competitors?

Shi: They have competed with foreign companies for a long time, but it is the weak domestic competitors who are getting weeded out first. . . .

At this point, more and more people in China are getting quite comfortable with buying domestically made brands, and they don’t want to pay the price of the premium [imported] brands.

Times: Name another favorite stock.

Shi: One company is called Founder Hong Kong Ltd. It’s the largest software developer in China, and I think all the major Chinese newspapers use its software now. Beijing University is a major shareholder of this company, and they have a lot of products that can be commercialized. At the same time they’re trying to penetrate the Japanese publishing market, because to some extent the Chinese language and the Japanese language are similar.

Times: Are you worried about the impact of the Chinese government’s recent decision to speed up privatization of state-owned companies? Some economists fear massive upheaval as people lose jobs.

Shi: Actually, in the southern part of China, which is more open to the outside world and ahead of the rest of the country [in this respect], a lot of smaller and medium-sized companies have already been sold to management and to employees. I think the 15th Party Congress’ new policy just gives them a stamp of approval.

State-owned enterprises used to make up 80% of the economy about 10 years ago. Now it’s under 30%.

Times: Still, the government faces the challenge of letting these companies sink or swim, which also means the Chinese banks that have lent the companies money could face trouble, right?

Shi: Basically, right now there are several ways to solve the problem. One is by reducing the interest or even forgiving the interest payments. The banks still get their principal back, but at the same time they will not get the interest back.

Another way to solve the problem is to swap debt with equity. So instead of waiting on some debt that will be never paid, they’re going to swap the debt for some equity ownership in that particular company. If the profitability improves, then the ownership of that property will be worth a lot more than the debt that is owed.

Times: What do you look for in Hong Kong companies?

Shi: Exposure to China. One company I invest in is called New World Development. It probably has the highest exposure to China of all the other property developers in Hong Kong. I like their strategy to penetrate China very much. They made huge investments after the 1989 Tiananmen Square incident when a lot of foreign money was going out. They were able to get a lot of good deals at the time because China was desperate to attract any foreign investment.

I feel the most undervalued sector in Hong Kong is small- and medium-sized companies. One company I like is Lamex Holdings, an office furniture wholesaler. . . . Lamex stock recorded 30% growth last year, and in the first half of this year it had 26% growth. The stock is trading at 10 times earnings, and the company’s growth from China has been 30% to 40% over the last few years.

Another company I like is Peregrine Investment Holdings. They’re the largest brokerage investment banking firm in Hong Kong, and their specialty is Asia. They have been hugely successful in China, they are very well connected and they have done underwriting deals for a lot of Chinese [initial public offerings].

Times: Red-chip stocks have been very hot this year, as investors bet that those large conglomerates will be favored to buy Chinese state-owned assets cheap as privatization continues. Do you own any red chips?

Shi: Yes. I have Citic Pacific Ltd., China Resources Enterprises, Shanghai Industrial Holdings, Beijing Enterprises Holdings and a lot of other names. I agree that they are probably trading at a valuation above even the Hong Kong blue chips, but you have to realize that they have the local knowledge in China, they know how to get deals done in China and they will be able to acquire a lot of assets at good valuation.

With privatization going on in China, [the red chips] will benefit tremendously. I don’t expect any great spectacular short-term performance. But I think over the long term they’re going to do well.

Times: Are there good buying opportunities in Southeast Asia?

Shi: For the next year or so China will still look pretty attractive compared to those markets. But if you have a two- to three-year investment horizon, I think the recent crisis probably represents the worst that will happen and now is probably a very good time to invest in Southeast Asia again.

Singapore’s economy has mended very well, and the export sector has been very, very strong. If you have an even longer horizon, I think the Thailand and Philippine markets are interesting. The Philippine economy is getting very competitive.

South Korea is going through a huge asset deflation crisis and to some extent a banking crisis as well. It really depends on how the government deals with the situation. If we see further deregulation and if we see further market-opening measures, South Korea will be a very interesting choice.

Times: Do you hold a large cash position in your fund?

Shi: To some extent, I was lucky because I had about 20% cash when the [Southeast Asian currency] crisis happened. It’s not because I can’t find any stocks to buy, but I wanted to wait for further confirmation on some Chinese companies that are doing well within their industries.

I really like to see market corrections because they offer me opportunities to buy stocks cheaper. But some investors don’t deal with corrections as well as I do.

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U.S. Global Investors China Region Opportunity Fund

Strategy: Seeks to profit from economic growth in China by investing in the stocks of companies of mainland China, Hong Kong and neighboring countries.

VITAL STATISTICS

Year-to-date total return:+8.5%

1-year total return, to Sept. 30:+38.7

1-yr. total ret., avg. China-region stock fund:+25.2

3-year total return, through Sept. 30: +4.6

3-year total return, average China-region stock fund: +19.8

Five biggest holdings: 1. HSBC Holdings 2. Citic Pacific 3. Guangdong Kelong Electric 4. Shanghai Dazhong B 5. Hutchison Whampoa

Sales charge: noneAssets: $42.2 million

Min. investment: $1,000Phone: (800) 873-8637

Morningstar risk-adjusted performance rating, 1-5: HH

Sources: Lipper Analytical Services, Morningstar, U.S. Global Investors