Jason Hsu is chairman and chief investment officer of Rayliant Global Advisors, based in California and Hong Kong. A widely published economist affiliated with UCLA, he devises quantitative strategies that are used to invest $22 billion, mostly in China.
EMBLOG: You’re a quant investor who focuses on China. But Chinese markets are often moved by politics and the emotions of retail investors. How does a quant approach fit with that environment?
JH: We are not in the forecasting business. That is not at all what quants do. We look mostly at retail behavioral patterns. Markets where there are numerous shocks will create persistent over- or under-reactions that are quite predictable. One of the more reliable patterns is that China will have lots of mini-bubbles, often driven by policy tailwinds, that dissipate fairly rapidly. We are seeing a correction from one of those now.
EMBLOG: So does the correction have further to go?
JH: We are probably just at the beginning, but people are unwilling to face the music. They are hoping there’s one last gasp. That said, much of the rally has been tech-specific. The broad valuation of Chinese shares is about at a historical median, and financials are relatively cheap.
EMBLOG: So you’re looking for a rotation play out of Chinese tech and into banks and other value stocks?
JH: We very much like the banks. China Merchants Bank (ticker: 3968.Hong Kong) is one of the most efficient. They’ve been strong-armed into lending to companies with lower credit quality, but they’ve built a massive bad debt reserve against that. As growth and tech rotate toward value and financials, the high quality banks are likely to outperform.
EMBLOG: Where is Chinese macroeconomic policy now? They stimulated the economy last year like everyone else. Are they tapping on the brakes now?
JH: In China, you have much more specific targeting of capital or subsidies, typical of an interventionist government. They are directing capital away from some of the hot sectors, where you have a flood of suspect projects. Elsewhere the spigot has not been turned off.
EMBLOG: Does the tech sector really need state capital at this point? It seems like there is plenty of capital available from markets.
JH: Sure, companies like Alibaba (BABA) or JD.com (JD) are cash-flow positive and stand on their own. But at the venture capital/ private equity level, there is a lot of support from state investment funds and local governments. For example semi-conductors have received an enormous amount of capital from various government funds.
EMBLOG: But China has spent the last year or two making it easier for tech companies to raise capital. They have eased IPO requirements and launched the STAR Market, which is meant to be the Chinese Nasdaq. Are they changing their minds?
JH: A lot of Chinese policy has an idiosyncratic component, which makes it “flexible.” It’s a little bespoke to the situation. Ant Financial [whose IPO was canceled at the last minute in November] was a signal that authorities want to throw some cold water on the internet sector. However, there isn’t a clear policy on exactly what’s “not okay” when it comes to disruption. I wouldn’t be surprised if all the tech giants that had plans to disrupt banking or insurance go to their regulators now and ask, “How do I do this? I didn’t think I would need a license to do banking or insurance through an app.”
The market has served China well in terms of bringing prosperity. But the quality of prosperity is not always what decision makers, or probably the broader society, want. Online payday lending, for instance, is not the innovation that people want. The government is willing to relax GDP targets now for more income equality, and green targets.
This policy attitude shift has a lot of tech firms scared. The government assessment, fair or not, is that a lot of the tech profits come from lending to lower-income households to consume irresponsibly. The short-term excess consumption-based prosperity could be long-term self-defeating.
EMBLOG: How does this fit with the broader objective of rivaling the United States as a high-tech power? They need private companies to close the semiconductor gap, for instance.
JH: They are not so naive that they think a state-owned semiconductor company can catch the U.S. But the state can involve itself through subsidies, research grants to university scholars, and state investments.
EMBLOG: What about the threat to delist Chinese companies from U.S. exchanges, which now has the force of law in the U.S.? Will the Chinese government seek a compromise that allows these companies to comply with U.S. audit requirements.
JH: My guess is that the Chinese government will play coy. They’ll be plain that the Holding Foreign Companies Accountable Act is an anti-China political attack. Then they’ll let Alibaba and the other companies figure out how to negotiate with the U.S. The actual bite of not being listed in the U.S. may be significantly lower than anyone would like to believe. After all, being listed in Hong Kong and Shanghai are nearly as good from a cost-of-capital and liquidity perspective.
EMBLOG: Large institutional investors love to say they’re focused on the long-term, maybe 3-5 years, when they buy a stock. How can they do that with the volatility you are describing in China?
JH: Chinese stocks are more volatile. However, their low correlation with global developed equities make them risk-reducing in a portfolio context. Additionally, the stock-specific volatility is driven by high retail trading. If you’re looking at Alibaba, Tencent (700:Hong Kong) or some other large caps listed in Hong Kong, the ability of retail investors to move those is minuscule. But with mid-caps and A-shares [traded in Shanghai or Shenzhen], you sort of have a Game Stop every day. Not to understand and exploit that excess price volatility is leaving a lot of alpha on the table.