Exploring a differentiated strategy, Federated Hermes Asia ex Japan Equity, focusses on undervalued opportunities across various market sectors. Investment director, James Cook, shares insights into contrarian investing, explaining how the fund’s approach differs from others and discusses significant market dynamics in China and South Korea.
Why you should listen to the interview: This interview offers a fresh perspective on Asian investing, highlighting a contrarian strategy that challenges conventional approaches. By focusing on undervalued opportunities, regardless of market cap or quality, the discussion provides valuable insights into navigating the complexities of the region, particularly in China and South Korea, making it a must-listen for investors.
This interview was recorded on 2 September 2024. Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, please listen to the full interview.
Interview highlights:
It’s about value, not quality.
“I guess the first way that makes us different is we don’t mind what quality we get in terms of the companies we’re investing in, as long as we get it at a good price.
“If I can use an analogy, we are happy to own a $50,000 Ferrari. We think that’s a great price for a Ferrari, but equally, if we cannot find a Ferrari at that price, we’re happy to own a Ford at $5,000. And that makes us different because many fund managers are only interested or focused in high-quality and fast growing companies. And that focus on quality and growth can limit their universe of opportunity and we think opens them to a potential mistake to overpay.
“And you only have to go back to 2020, the year of growth, when you could see managers were indeed prepared to pay an ever higher price for the quality. We are not gonna pay $200,000 for a Ferrari. And certainly for a while now, the very high-quality companies in our market have been extremely expensive. And we’ve held an overweight to ‘Fords’ because that’s where we found the most attractive opportunities, and that’s resulted in our historic value bias, which still holds today.
“But importantly, we’ve survived what has been a very hostile environment for value investors precisely because we’ve never been pure value or deep value. We’ve had a mix of ‘Fords’ and ‘Ferraris’, but definitely more ‘Fords’, which remains the case today.”
The ultimate contrarian play
“China has been the ultimate contrarian place certainly for the last several years. And it’s been a very easy and comfortable trade for a lot of investors to be short China. It’s been so out of favour and particularly with foreign investors. And that has resulted in the record low evaluations that you see today relative to the rest of the world.
“Now we’ve never been afraid of bad news. You don’t tend to have good news and good valuations and the Chinese economy is clearly going through a tough period. And that is reflected in the discount that you see today.
“But it remains our view that the longer the market stays weak, the higher the chance will be that we will see an increased response. Whether that’s a major fiscal or monetary stimulus, which ultimately will help the property market to recover and maybe mark a turning point in equities. But what you have is a market that is extremely cheap.
“And there are thousands of listed companies in China, and historically it’s been the case that we’ve had to look in the brambles to find the most attractive opportunities. Today, you have high-quality companies, or companies we assess to be high quality, trading at the same multiples as perhaps the more cyclical older economy. Some stock prices have simply fallen too much.
“We believe the market has found a flaw and the upside from any reasonable re-rating could be significant from here.”
The high-quality appeal of Korea
“Korea is a another market where we find exceptionally attractive valuations. It is a market with many high-quality companies from a business perspective, global leaders in their own fields. Many of them are in technology in the auto space and other growth sectors, but they are trading at a discount certainly to their US peers and also within the region to Taiwan peers.
“Korea has long been a value market, and a lot of the Korean discount is due to poor corporate governance. But in Korea you have a burgeoning activist class. It’s something we’ve seen through the Covid period, a growing participation from retail investors. And in Korea today, more than a third of the electorate participate in the stock market, which has one of the lowest payout ratios in the world, and hence that discount that you see and things are starting to change. And there is a lot more focus for companies on shareholder returns there.
There’s a long way to go and we firmly believe that you need to see the law change in terms of tackling some of the ways the founding families that control a lot of Korea’s largest companies have mistreated minority shareholders in the past. But what we’ve seen this year is certainly those companies that do have excess cash on their balance sheet and particularly ones not controlled by founding families, have sought to increase their payouts. So there’s green shoots of change underway, which gives us hope.”
It’s all about starting point.
“But from our bottom up contrarian perspective, we are very excited about the prospects for the Chinese stocks that we own, that are trading at near record valuations and the Korean companies that we see exceptional value. We are positive about the prospect of both countries.
“Humans tend to sell low and buy high, and in those moments, they believe it’s for a good reason. The longer a market trends lower or higher, the more confident people become that tomorrow will look like today. And what they forget is the most important, the single most important consideration investing is your starting point. And for us, that’s the price you pay.”
Conclusion
James Cook provides a comprehensive overview of a contrarian investment approach in Asia ex-Japan, exploring the nuances of undervalued opportunities in China and South Korea. The insights shared offer a valuable framework for understanding the unique dynamics of Asian markets, leaving listeners with a deeper appreciation of the opportunities and risks involved in this diverse and evolving region.
