February 2021 Webinars

We would like to invite you to participate in our February webinars. We will be providing an outlook for the Asian financial markets in 2021.

Asian Equities Update

Webinar Details:
Asian Equities Update

Date: 24th February 2021
Time: 11:30am - 12:00pm AEDT

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Emerging Markets Fixed Income Update

Webinar Details:
Emerging Markets Fixed Income Update

Date: 24th February 2021
Time: 3:00pm - 3:30pm AEDT

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Presented by:
Premium China Funds Management
Jonathan Wu - Executive Director | Head of Distribution and Operations | Chief Investment Specialist

ABOUT PREMIUM CHINA FUNDS MANAGEMENT

Premium China Funds Management is a boutique funds management group established in 2005 to bring Asia investment opportunities into the Australian market, in order to bridge the gap between investors' needs to internationally diversify and the suite of investment solutions available.

The business team is comprised of six key individuals - Simon Wu (Executive Chairman & Chief Investment Strategist), Dean Groundwater (Director), Jonathan Wu (Executive Director & Head of Distribution and Operations), Derek Paas (Asia Investment Specialist), Clayton Coplestone (Investment Specialist - New Zealand) and Kevin Hu (Manager - Operations and Research).

Tony Bremness, Managing Director & Chief Investment Officer of the Laureola Investment Fund, discusses the performance of the fund over the last quarter of CY20.

The Fund invests in Life Settlements. Since inception in May 2013, it has returned +16.36% p.a. with an annualised volatility of 5.60%.

The pivotal fight between China and the US is over the microchip

Michael Collins, Investment Specialist, Magellan Asset Management

January 2021

Teaser: The campaign for dominance in semiconductors could hurt both countries.

Japan's Kioxia Holdings, which in the early 1980s invented flash memory computer chips, was set for one of the country's biggest initial public offers for 2020.  In September, however, the semiconductor maker reduced the asking price of its offer by 25%. Days later, the company postponed indefinitely a float that was initially set to value the company at US$16 billion. Kioxia's CEO blamed the IPO suspension on "market volatility and ongoing concerns about a second wave of the pandemic". Given that at the time the Nikkei 225 Index was close to its highest in three decades, that explanation didn't wash.

Everyone knew why Kioxia halted its IPO. Anonymously sourced media reports had warned Kioxia would abandon its float because China-US tensions were reducing the company's profitability. Of note for Kioxia's fortunes, the US in August decreed that non-US companies would need Washington's permission to sell microchips made using US technology to Chinese telco Huawei Technologies and its affiliates. The talk was that Washington's restrictions on Huawei would cost Kioxia sales and lead to a global glut and thus lower prices for flash-memory products.

The US restrictions on Huawei sting because China makes less-advanced microchips and relies on more-advanced US supplies. China is aware its inferior chipmakers make the country vulnerable amid the 'decoupling' between China and the US that is centred on technology. Beijing thus intends to become the best and self-sufficient in the pivotal microchip industry that is worth more than US$420 billion a year in global revenue, where half the sales are to Chinese firms.

Microchips form the key battleground in the rivalry between Beijing and Washington because the integrated circuit - a piece of silicon that contains nanoscopic electronic circuits - ranks with the internal combustion engine and electricity as an invention of consequence for everyday life. The integrated circuits pioneered in 1958 by Jack Kilby at Texas Instruments when the US military was seeking a lightweight computer for the Minuteman missile's guidance system underpin so many essentials to modern life it can be said that we are in the microchip age.

As Beijing and Washington see it, the country with the best 'brains of computers' will dominate biotech, business, cyberwarfare, economic, military and other fields. Both will mobilise vast financial and political resources to ensure their microelectronics industry is the world's best - and China is behind in production facilities and technical know-how in this US-private-sector-dominated industry, even if most microchips are made in US-allied countries such as Taiwan and South Korea.

A microchip industry split on Sino-US lines decades after the industry established global production networks, however, will come with costs and risks for both countries and the world. For US and allied companies, lost sales to China, reduced economies of scale and lower prices mean reduced profits, less research and fewer advances in chip technology. The risk for the US is that the country will lose its commercial and military edge in chips that are heading into their third generation of semiconductor materials.

China's decision to elevate microchip self-sufficiency and excellence to a national priority means that billions of dollars are destined to be spent to ensure China has the best semiconductors. The cost of this, in theory at least, is that resources are being diverted from elsewhere. Chinese businesses and consumers could face higher-priced chips than otherwise and these might still be inferior to foreign peers (just like Australia's protected car industry meant higher prices for vehicles). The overarching risk for China is that in pursuing self-sufficiency Beijing is turning towards protectionism and government direction as an economic development model. 

For the world, the cost of the microchip wars could entail slowed advances in almost every field, which spells opportunities and wealth forgone. Increased tensions between the world's biggest powers over this tiny technology could change the global balance of power and might turn their rivalry into hostility, perhaps over Taiwan, the world's biggest source of made-to-order chips. China, the US and the world would be better off if the microchip wars was toned down.

The competition over microchips could, of course, lead to advancements that help the world. The battle over chips has been simmering for a while - Beijing, for instance, stymied Qualcomm's bid for NXP Semiconductors in 2018 for security reasons - with little harm done seemingly. The US is granting exceptions to its microchip bans to Huawei's smartphone business, so maybe the chip wars will be a phony confrontation. Chinese companies are said to be sitting on vast stockpiles of US production inventories so the sting of the US actions might be delayed and Sino-US rivalry might settle down. If the chip war were protracted and heated, the costs of the contest could be mostly hidden for society at large. Few people would be able to quantify lost advancements, reduced capabilities, higher costs than otherwise, lower speeds than otherwise and unknown alternatives forgone. So why worry?

Because regions vying for self-sufficiency in semiconductors is a recipe for disrupting the global microchip industry at a time when ageing and depopulating western societies with debt-ridden economies need all the productivity boosts they can get. And the global political ramifications would be vast if China were to overtake the US in semiconductors, given the associated changeover in global power.

Autarky in tech by 2035?

The Chinese Communist Party in October held the 5th plenary session, or annual convention, of the 19th Communist Party Central Committee, which, along with the National Congress that appoints the committee, is one of the party's two highest decision-making bodies. The key job of the plenary session was to devise the 14th Five Year Plan (2021-2025). At the end of the session, the party issued a communiqué that unexpectedly in the title included the words "and 2035 long-term goals".

The release said the party had bought forward by 14 years to 2035 the goal for China to become a rich country radiating "scientific and technological strength". (Deng Xiaoping, the leader who launched China's reforms from 1978, had previously set 2050 as the year when China would achieve "socialist modernisation", Beijing's term for parity with the US.) The plenum release said that by 2027 the country would achieve its goal of having a modern military by "strengthening the army with science and technology" by optimising "the layout of the national defence science and technology industry". To help achieve economic and military goals, the party elevated to a "strategic support" self-reliance in technology, which implicitly prioritises excellence in microchip production as a national goal under China's new 'dual circulation' economic model. This is the term for Beijing's policy of self-sufficiency in critical industries such as technology and energy that has seen it set aside an estimated US$1.4 trillion for tech by 2025.

China has much to achieve in microchip expertise if it wants to surpass the US in semiconductors on this timetable. The US restrictions on Huawei, especially the curbs in May that stopped the Chinese company receiving supplies from Taiwan Semiconductor Manufacturing Company or TSMC, the world's largest chipmaker, exposed the hollowness of China's 2015-launched 'Made in China 2025' plan to dominate in future technology spheres such as artificial intelligence, biotech, driverless vehicles, fifth-generation telecommunications, quantum computing and more (and in some areas, especially 5G telecoms, China is already a leader). Without excellence in semiconductors, first marked as a Chinese priority in 2014 when Beijing set up a US$150 billion investment fund focused on chips under what was known as the Guidelines to Promote the National Integrated Circuit Industry, the wider goals are hard to achieve.

Irking also for China's leaders is that much of China's supply of world-class semiconductors comes from what Beijing considers to be its rogue province of Taiwan - that's where headed the losing Nationalist side in the civil war that bought the Communists to power in 1949. TSMC, the world's best at making sophisticated chips, must heed the US restrictions because it relies on manufacturing equipment that contains US technology and the US is the largest destination of TSMC's exports. China's other major sources of memory chips are South Korea's Samsung and SK Hynix and Micron of the US. Chip products from these companies can be easily blocked by Washington too.

Thus Beijing is seeking self-sufficiency. China has already invested billions of dollars to boost chip production and can boast gains. From virtually no production in the late 1990s, China produces about 15% of the world's chips now and that number could treble within five years. Semiconductor Manufacturing International Corp, China's biggest contract chipmaker usually known by its initials SMIC, and Yangtze Memory Technologies, China's first 3D NAND flash memory maker, are among Chinese companies setting goals to use local and non-US equipment in production to circumvent US restrictions. Alibaba and Baidu are investing in microchips while Huawei plans to build a microchip production plant in Shanghai. Government subsidies are reportedly encouraging many more Chinese companies to enter the industry.

But there are questions over the sophistication of Chinese microchips (though not the quantity it is capable of making). US companies dominate the software that designs the most advanced chips such as sub-10 nanometre chips. US companies Applied Materials and Lam Research and ASML of Europe and Japan's Tokyo Electron dominate the production (fabrication) process for advanced semiconductors. Through these companies, the US government can control which allied countries have access to the cutting-edge technology used to design and lay out chip circuitry. It is a formidable task for China to overcome its shortfall in intellectual property but not an impossible one.  One help for China is that the petering out of the corollary to Moore's Law - that chip capabilities increase due to a doubling in the number of transistors per chip every two years - might mean the gap to the US edge is shrinking.

China's pledge to get better at making microchips could lead to advances that help society and the wider world. But the billions, even trillions, of dollars to be invested in an invention already more than 60 years old is only likely to lead to incremental improvements rather than breakthroughs. The money to be spent will come with 'opportunity cost', a term that economists use to describe the alternatives foregone. Sums to be spent on microchip development are amounts diverted from elsewhere.

Some warn that China is reversing the opening up to the world that led to its industrialisation, an about-turn that could backfire in terms of the country's advancement. Even if China were to gain an edge over the US in chips, that feat would likely only provoke greater tensions with the US and its allies.

US leadership under threat

Perhaps the start of the microchip wars dates to 2017 when one of the last acts of the administration of US President Barack Obama was to unveil a strategy to secure US supremacy over semiconductors in regard to China. Congress during the administration of Donald Trump built on that proposal with legislation such as the CHIPS for America Act of 2020 and the American Foundries Act of 2020 that offered tax breaks and grants respectively to bring the microelectronics industry back to the US. Other developments of note include Washington's ever-expanding trade blacklist that specifies restrictions on Chinese organisations for aiding certain Chinese government policies. Companies ensnared include Huawei, Chinese telco ZTE in 2018 and SMIC in October last year. Other events in the chip wars extend to the US blocking the supply of sophisticated manufacturing equipment to China such as when in 2019 the Netherlands government decided not to renew the export licence for ASML's extreme ultraviolet scanner to SMIC. More still include blocked takeovers such as Washington's refusal to allow Singapore company Broadcom to buy Qualcomm in 2018 due to fears of loss of control of intellectual property. Such decisions come with costs for the US side, most obviously in lost sales for US companies. An overarching danger for the US is that the strategy backfires by costing it leadership in semiconductors.

Boston Consulting Group, which estimates the US market share in chips at 45% to 50% in 2018, says US leadership is grounded in a virtuous innovation cycle. The pivotal advantage of the US is that access to global markets has allowed US chipmakers to achieve the economies of scale needed to fund huge investment in chip research and development that has consistently advanced US technology ahead of global competitors (at least until recently).

Boston Consulting reckons that China's semiconductor industry (not including the manufacturing facilities built by foreign semiconductor companies in China) covers only 14% of its domestic demand. It estimates the Made-in-China-2025 plan could increase China's semiconductor self-sufficiency to about 25% to 40% by 2025, which would reduce the US's semiconductor share globally by two to five percentage points from 2018 levels.

Every time Washington broadens restrictions on Chinese access to US technology, US market share loss deepens. The consultancy warns that US companies could lose 18 percentage points of global market share and 37% of their revenues from 2018 levels if the US completely bans semiconductor companies from selling to Chinese customers. Plunging revenue would force US microchip makers to slash research and investment, thereby reversing the US industry's virtuous innovation cycle. "As a result, South Korea would likely overtake the US as the world semiconductor leader in a few years; China could attain leadership in the long term," the consultancy warned.

It would be a different world if China were the global leader in advanced semiconductors. And, as the experience of Japan's Kioxia shows, it could be a lesser world as China and the US fight to dominate a world defined in nanometres.

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Making Sense of Nonsense

Robert Swift, Delft Partners

February 2021

If something is too hard or whacky then there is a tendency to ignore it and hope it goes away. The recent bizarre price moves in GameStop and AMC and other 'marginally solvent' companies is just such a case in point. However, 'hope' is not a strategy and it can pay to rummage in the information cellar where you might find something useful / or learn a lesson? So we'll have a stab at making sense of what looks like nonsense. We might come to a useful conclusion?

Briefly what has happened is that certain financially and strategically challenged companies have seen their share prices rise suddenly and dramatically to levels way beyond rational. (Isn't the whole market irrationally priced? Ed.) This has caused large losses by funds which had short positions in these companies.

It is not unusual for short positions to go wrong. We have run hedge funds and can testify that while we were careful to hedge our shorts with longs as best we could using risk models and a great deal of pragmatism and modesty, we still occasionally got 'whacked' by a short going against us with a wild and what seemed like unexplainable lurch upwards.   

Three aspects strike us as being noteworthy here in this recent spate of irrationality.

1. Short positions are potentially unlimited in their loss making. Consequently short positions should be hedged by long positions in risk equivalent factors, and constantly trimmed or fed. As we observe them, in many 'hedge' funds, there is no hedge; nor is position sizing as a % of client capital prudent.

For what it's worth we had more but smaller positions on the short side because they tended to be more volatile and more correlated. Additionally we shied away from remaining short a very small market capitalisation because bankruptcy meant that we couldn't buy back our short position since trading tended to get suspended, and that at that point the specialists in business reconstruction got involved and would know more than we did. Remember that at one point GameStop was trading at about $3 and as such had a market capitalisation of about $200m. What was the point of being short that if the market cap was shouting 'imminent bankruptcy'?

We don't know enough about the hedge funds that got whacked but guess that a loss of that magnitude meant a pretty large $ position as a % of client capital and trying to pick up pennies in front of the steam roller- when suddenly the steam roller sped up.

This stuff is so self-evident we will write no more on this.

MUCH more interesting is the fact that:

2. The short positions were very heavily advertised &
3. The buyers were also working to advertise their actions to the market

So we think the broader issue here is 'market manipulation' - on both sides of the ledger. It has been represented as "nasty evil hedge funds" aka the establishment vs brave individuals working together to earn a crust. Yet aren't both sides aiming to profit as 'consenting adults' with loud voices in a liquid market which has been increasingly heavily regulated and supervised?

Has the pursuit of profit entailed market manipulation (which is illegal) and if so, how is this alleged manipulation by the buyers of GameStop so different from what routinely happens?

Movies have been made - Boiler Room's pump & dump, Wolf of Wall Street, for example - about market manipulation and fraud. Research companies routinely make pronouncements about how company X is using fraudulent accounting and that they expect bankruptcy - all the while with a short position or being paid for their research by funds with a short position.

If investors work the other side 'in concert' to drive up a company's share price in the knowledge that short covering will kick in, is this not the same?

So which bit if either, is illegal? Which bit is just "business"?

Additionally one may argue that if I'm the CEO and I make some comments in an analyst call, abiding by Reg FD, I can move the stock. If I benefit from that too obviously, I go to jail. But if I buy back the company's stock it has the same effect. That's not illegal. Although I still benefit.

There are however rules on buy backs but not on short selling research, nor on trading to squeeze the shorts. The difference here then perhaps is that it is NOT the company which is disseminating the news but market participants trading against each other. So we have to ask whether this is to be discouraged by more regulation on the basis that it is damaging to the economy or dangerous for individuals who need to be prevented from self-harm.

We hope not. We are (naïvely?) convinced that stock market prices contain information; when 1 stock goes up, we think that is because fundamentals have improved, or the company's outlook has or something macro has changed that affects the company. Aside from GameStop, we've seen Softbank allegedly deliberately manipulate the market very recently. If you believe fundamentals will reassert themselves then you use this irrationality as part of your process. Run-ups in stocks trigger momentum models which should be part of any risk model menu. Serial correlation leads to understatement of volatility and portfolio managers assuming too much risk complacently. So portfolio managers should incorporate the risks in price momentum and serial correlation in their portfolio construction.

For the retail crowd, this just calls into question the wisdom of following ponderings spilled daily by people like Jim Cramer about XYZ stock being up 20% or biggest gains/losses of the day. If there's no information content/price discovery in the stock market and price moves can be ruinous, that should force us all back to fundamentals, which then becomes an opportunity to talk about how out of date our accounting statements are versus modern business and the difficulty of pricing intangibles. We recall in the mad Asian frenzy of the early 1990's how stock splits would cause a frenzied buying on the KL exchange by retail investors because "you got more shares for your Ringgit" as was explained to us. We also saw this behaviour in China almost two decades ago when the market was dominated by retail traders chasing news. To the best of our knowledge the Chinese did not change much at all but let losses fall where they did. The US should be capable of letting this outcome befall all investors - retail and professional.

Funnily enough we professionals DO already live with and utilise a lot of irrationality such as the January effect, price momentum as a strategy, and the so called Santa Claus effect. We actually rely on it since our investing strategies incorporate other people's irrationality! So simply put we should seek more news flow since news flow reduces information hoarding.  

Our conclusion in this specific US example is this. If you can't bear losses, don't play - either as a retail investor or as a professional. Retail may be sneered at as 'stupid' (unorthodox) but they too have a right to play?

It's more worrying to us that this strange turn of events is symptomatic of a broader malaise? This behaviour is symptomatic of a late stage capital markets circus with a belief in perpetually free money and a free get out of jail/trouble card always at hand. There's plenty of froth around, as evidenced by the listing of over 272 SPAC (Special Purpose Acquisition Companies) which have raised US$88 billion since August 2018... of which 193 with $63 billion are still searching for a target... and with 219 raising US$73 billion in 2020 alone. 1929 anyone?

Fake news and 'crowd think' isn't confined to "Freddy Starr ate my Hamster" nor that "Elvis Presley is living on the moon" but now permeates the stock market too and continually fed by poor monetary policy.

It is absolutely crucial that we prevent moral hazard permeating more deeply into the financial system. It's not more regulation we need here, it's "more consequences" and an acceptance that there should be no free put option.

We'll finish with a quotation from JM Keynes writing in the 1930's after the crash. It's not Reddit nor GameStop nor AMC we should be blaming, but what has led us to this systemic speculation?

"Speculators may do no harm as bubbles on a steady stream of enterprise," he wrote. "But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."

If you want more thoughtful pieces on the rigged casino that has been created by years of policy ineptitude, then we can happily supply you with William White's latest thoughts.