China Consumer Drives 32% Oberweis Fund Gain as Economy Weakens

Jul 30, 2014 7:08 am ET

July 30 (Bloomberg) -- China was a tough sell when John Wong first started pitching the country to investors in the 1990s. Now, after a long boom that turned China into the world’s second-biggest economy and reforms that tamed its torrid expansion, it’s difficult again to drum up investor interest in the country, says Wong, manager of the Oberweis China Opportunities Fund.

China’s growth this year is forecast to be the slowest in 24 years, Bloomberg Markets magazine will report in its September issue. The country’s first-ever onshore corporate bond default in March rekindled concern about its murky banking system. Against that gloomy backdrop, Chinese shares are trading near historic lows, even as demand from the country’s burgeoning middle class drives revenue gains at smaller companies, Wong, 51, says.

“Why are Western investors so bipolar about China?” Wong asks. “This is a good time to invest, when everyone is fearful.”

The $207 million China Opportunities fund gained 32 percent in the 12 months ended July 29, after soaring 60 percent in 2013, and ranks in the top 5 percent of similar funds over the one-, three- and five-year periods, according to data compiled by Bloomberg. Wong and co-manager Jim Oberweis focus on smaller firms, with the market value of the fund’s companies averaging about $2.5 billion, Wong says. Its holdings are concentrated in retail and technology. Powering gains last year were stocks such as Maanshan-based milk producer China Modern Dairy Holdings Ltd. and Shenzhen-based Internet company Tencent Holdings Ltd. Shares of both almost doubled in 2013.

That contrasted with the overall trend in China’s stock market, which skipped the global rally last year. The benchmark MSCI China Index rose 0.4 percent, while MSCI’s World Index jumped 24 percent.

Slowing Growth

Premier Li Keqiang is trying to rebalance investment toward the domestic economy and away from industries that have excess capacity or spew pollution. The government is targeting 7.5 percent growth in gross domestic product this year, while economists surveyed by Bloomberg forecast 7.4 percent, the slowest pace since 1990. Wong says what’s more important is that future growth is keyed to the expansion of the middle class.

“So even if it’s growing at 7 percent, I think it’s still relatively healthy,” he says.

Wong says that China’s development can be characterized by three Cs. Cheap labor came first and lasted into the 1990s. Copycat technology and industrial development followed in the 2000s. Domestic consumption defines China’s growth now, with smaller companies leading the way, he says.

Founder Ethos

The fund is partial to firms that are still run by their founders, as their interests align with those of shareholders. Many Chinese entrepreneurs have gone to school or worked in the U.S., Wong says. “They have some experience as far as corporate governance is concerned,” says Wong, who was born in Singapore and studied business at Stanford University in California. “When they return to China, they typically try to do the same thing as what they learned here.”

Lisle, Illinois–based Oberweis Asset Management Inc. oversees about $1.5 billion, with more than half of it invested overseas. Wong joined Oberweis from Wells Fargo & Co. in 2007, two years after the China Opportunities fund was started. Oberweis, the president of the firm, says China was a natural fit for the company’s focus on growth stocks. Oberweis took the reins at the firm after his father, also named Jim, stepped down in 2001 to run for the U.S. Senate in Illinois, losing Republican primaries in 2002 and 2004. Barack Obama won the seat in 2004. “What we do well in the U.S. is find pockets of misvalued stocks in areas of rapid change,” Oberweis says. “In China, you have all those things on steroids.”

‘Still Early’

Even so, institutional investors remain cold on the China story. When he started the fund, Oberweis thought major investors would establish allocations to China in the way they often do for the U.S. and European markets. “That part has not yet materialized,” he says. “It may still. It’s still early.”

One challenge in searching out good investments is making sure a company’s books ring true. Oberweis has two analysts in China: one in Hong Kong and one on the mainland. Wong makes regular trips there from his home in Cupertino, California. “We do our own homework,” he says. “We don’t outsource our due diligence.”

Oberweis screens for companies whose revenues are growing 20 to 30 percent a year and that have a price-earnings–to- growth, or PEG, ratio of less than 1. If the ratio rises above 1, a sign that the shares are fairly valued, the fund managers will consider selling, Wong says. The same applies if the company starts to expand into a new business.

Limited Resources

“Resources are limited for many of these companies, not just cash but management bandwidth,” he says.

Urbanization is a critical theme for China investors, Wong says. About 78 million people will move from villages to cities by 2020, he says, citing research estimates. The key to getting exposure to such growth is finding the smaller companies at the leading edge of social change.

“That’s where you see entrepreneurs who are nimble enough to take advantage of the opportunities,” Wong says. “And you ride with them.”