Tech Arms Race: Is China already winning?
Names like George Soros, Howard Marks and Ashok Jacob are recognisable to most investors. Mary Manning has the unique experience of working inside the investment engines of each of these renowned fundies. Their ability to step back and think about big picture issues is one trait that has been impressed upon her.
In 2018, Mary and her team at Ellerston Capital published a research paper titled; "Tech Arms Race: Is China Already Winning?" It outlined a thesis that the geopolitical tensions taking place between China and the US were a sideshow. The real battle was over technology and, in her view, it remains the biggest issue in global markets right now.
Jack Ma, the founder of Alibaba, has just filed paperwork to commence an IPO of Ant Financial, the payments business sitting within China's answer to Amazon. It's set to be the biggest listing of the year with estimates that Ant Financial will hit the boards with a valuation between US$200 bn and US$300 bn. In a world starved of growth, Mary believes that the opportunities in Asia are simply too compelling to ignore.
In this extended interview, Mary discusses the thinking behind her thesis, outlines how she is investing right now and shares a lesson that she has taken from each of the great investors she has worked alongside.
"Ray Dalio has said it better than I ever could; if this is a two-horse race between China and the US in terms of global economic dominance and dominance in tech, why wouldn't you bet on the second horse?"
- Reflections from working with three great investors; George Soros, Howard Marks and Ashok Jacob.
- The compelling structural growth opportunity that exists in Asian markets.
- Why the ‘tech arms race’ is the biggest issue facing investors globally.
- Who is winning and where in the race for tech supremacy?
- Investing in Asia’s tech giants and why size is an advantage when it comes to growth.
- The next big tech player emerging in Asia.
- Three tough lessons Mary learned from Soros, Marks and Jacob.
Question 1: Can you tell me about your journey as an investor and some of the people that have had the biggest influence on you along the way?
Mary Manning: If I look back on my career, I have been very blessed to work for such amazing people in the finance industry. When I started working at Soros, I was literally fresh out of business school. I had graduated about two weeks before and I was pretty clueless! Soros wasn't in the office that often and the first time I met him was actually at the Council on Foreign Relations (CFR), which is a big thinktank in New York that brings in a lot of experts and world leaders. Prime minister Koizumi, who was the prime minister of Japan at the time, was giving this presentation and I went up and introduced myself to George and I said, "Actually, I work for you." And the next time I ran into him was also at the CFR with Thabo Mbeki, who was the president of South Africa at the time.
The reason I mention this is because one of my takeaways from working at Soros was that he and the organisation were very big picture thinkers. To short the pound the way he did, that's not something that you would come up with by sitting at your desk. You have to have a very big worldview in order to identify those sorts of traits. And the fact that, even at the age he was then, he's meeting with prime ministers and presidents and keeping that worldview very big, is something that left an impression on me. And it was also interesting to me that he made his money and a name for himself doing shorts. I obviously run funds that are long only right now, but it is useful to have the perspective that markets can be mispriced. And one trade can make your whole career. It's important even for long-leaning investors to keep that in mind, because you don't want to get complacent about the things that you own.
Q.2: And what was it like at Oaktree?
MM: Oaktree was an amazing place to work. It was very structured, unlike Soros, and helped me realise that sometimes being a good investor and building a business are two totally different skillsets. One of the things I appreciated about Howard Marks is that he's obviously an amazing investor and you have to think differently to be a distressed investor. When everyone else is running for the hills, that's when you step in. The skill is thinking differently, but also having the sort of mind and execution skill to be able to build a business. It is pretty rare to have both those things in the same individual.
When I first started at Oaktree, I worked for the emerging markets hedge fund. But, over the time that I worked there and after I'd left, they built it up to be many different products and offices all around the world. Then they did a backdoor listing, did a full IPO and finally they got acquired. The fact that you can build a business from a niche distress business to a behemoth that gets sold in about two decades is pretty impressive.
Q.3: You run Ellerston Asian Investments which is headed by Ashok Jacob. What influence has Ashok had on your career?
MM: Unlike George Soros and Howard Marks, I actually work directly with Ashok. It's a very engaged relationship and I really appreciate that he knows what's in your portfolio and he knows what people are doing. As with George and Howard, his breadth of intellect is very impressive. I appreciate having someone that you can talk to about anything and who knows what's going on in every country in the world. It’s very nice for me as a portfolio manager to have a boss like that. Because I run an Asia fund and we also have an India fund at Ellerston, it great to have someone who has expertise in investing in Asia. This is pretty rare in Australia.
Ashok has also been very supportive of me personally. He has been a sponsor and a mentor to me since I first moved to Australia and didn't know anybody. I had a young family and my husband was still living in Singapore so when I interviewed with Ellerston I said, "Actually, I only want to work four days a week because this is a difficult time." And he was fine with that. And after a year he called me into his office and said, "You're underpaid, I'm giving you a raise." A few years later, I suggested we start an Asia fund. I had looked at the market, done the analysis and there was a clear opportunity here. I was thinking at the end of that financial year we should have it up and going. And he got on the phone and called the CEO and said, "We're starting an Asia fund and it's going to start next week." To have someone who no matter what was going on was very supportive of me and what I wanted to accomplish, is extremely rare and I recognise that.
Q.4: Tell me about the opportunity that you saw and how you think about investing in Asia. What's your philosophy?
MM: The opportunity that I saw five or six years ago now, was that firstly Australia is extremely domestic focused. If you look at the size of the economy and the number of stocks that are available here, and then you look at the percentage of people's portfolios that are allocated to Australian equities, it doesn't make sense to me. This is not financial advice, but I also feel like a lot of investing in Australia is sort of a circular trade. You buy an Australian bank and it may well be the same bank that you have your mortgage in and your investment property in, and so everything becomes a circular trade.
After living here for a while, it seemed obvious that this was a market screaming out for diversification. Some funds have been very successful in taking that diversification trade and getting people into global equities. But in terms of investing directly in Asia, there really weren’t many options for Australian investors. Even today there's not much of a focus on emerging markets. It's like there's Australia and then there's global and that's it. But the type of companies that you get access to in Asia and emerging markets are obviously very different than what you would get in developed markets.
When I look at developed markets, including Australia right now, I don't see very many growth opportunities. Japan has been stuck in the doldrums for decades now. And Europe has been stuck in the doldrums since the end of the GFC. Despite over a decade of ultra-loose monetary policy, there's no growth. The US has managed to get some growth, but only because of ultra-loose monetary policy and major fiscal spend. If you look around the world, structural growth is extremely scarce. But if you look at Asia, there's lots of structural growth. Putting COVID19 to the side for a second, you have demographics, you have technological leapfrogging, you have infrastructure build, you have a rising middle class and rising consumption.
While it's hard to find growth in an Australian portfolio, Asia is right next door and has lots of amazing companies that can give you structural growth. That's the opportunity that I saw. And then, to answer your question about my philosophy, we are not going to Asia for value or dividend yield. If you want that you can get it at home or somewhere else. But Asia is the best structural growth story in the world so that's why I think you should be investing there.
Q.5: What's been behind that positive momentum and those strong returns in Asia? Is it homogenous and can you take us through the different drivers?
MM: No, it is not consistent. It is mainly technology although this is not particular to Asia as the technology sector is driving markets globally. If you look within Asia at countries that have no tech, their markets are not doing very well. Countries like Thailand, Malaysia, Philippines and Indonesia have no big listed tech companies and they're doing quite badly. But if you look at countries which have a lot of tech, like China, Korea and Taiwan, their markets are doing very well. It's a little bit complicated right now due to the impact of COVID19 but those technology stocks are really driving things. It is not dissimilar to the way that the NASDAQ is really driving things in the US.
Q.6: Are you seeing the same concentration of stocks in those Asian markets as well?
MM: Yes, and India is a good example. Reliance is a stock that we like, it's 16% of our India portfolio and it's a decent weight in the Asia portfolios. It wants to be the Tencent of India.
It is still a conglomerate, but it has this new economy business, which Google and Facebook have invested in it. For a while there during COVID, this one stock was single-handedly dragging the Indian market up. In March it was at 900 and now it's over 2000. So, when you have a stock that's 14% of the benchmark and that's doubled since March, that market's going to look like it's doing very well, but it's just the concentration in leadership which is driving that.
Q.7: When people think about China and the US markets at the moment, a lot of the focus is on trade tensions and on geopolitics. In 2018, you put together a research paper where you basically said that the tensions were about technology rather than about geopolitics and trade. Could I get you to explain that thesis and how it's played out since 2018?
MM: More than two years ago, my team and I started looking at the trade war because that was the defining characteristic of US-China relations at that time. This was when Section 301 of the Trade Act was in the news and a lot of the people in Trump's administration were going really hard on Section 301. Section 301 says a lot about IP theft and technological transfer and similar things. When you started digging into what they were doing on the trade front, it became quite obvious that it was about tech and not really about trade. Soybeans are not the flashpoint in US-China geopolitical tensions. It's the fact that, ultimately, this trade war is going to lead to a tech war and that's what's actually underlining it.
As you said, it was a very detailed white paper about two years ago and we presented it to a number of our investors and people in there were like, "That's nice. Okay, good work." But more recently, with the big crack down on Huawei, TikTok and WeChat, we've had investors call us and say, "Remember that thing you did two years ago about the technological arms race?" This potential tech Cold War is really at the front of people's minds right now. Our main thesis remains that the trade war is not about trade; it's ultimately going to be about technology, and this is playing out right now.
From a portfolio perspective, I have almost 50% of my portfolio in tech right now. It's actually 47%, but I have about 18% cash. So, if you adjust for cash, that is a very big bet on tech. Ray Dalio has said it better than I ever could that if this is a two-horse race between China and the US in terms of global economic dominance and dominance in tech, why wouldn't you bet on the second horse? Because the US has been running around the track for a long time in the lead, and China has been catching up. And given the speed at which China has caught up in tech, why wouldn't you bet on the second horse?
In the Asia fund, we have a huge bet on the second horse right now. Companies like Tencent, Alibaba, TSMC. And not just China stocks but Asian technology stocks like Samsung, TSMC, supply chain stocks, Reliance, JD and Baidu. There's a whole amazing suite of stocks that investors can have access to, which will do very well. They may not all benefit from a tech trade war, but the fact that the US is so nervous about this suggest that there's really something amazing going on here and that's why they're pushing back so hard.
Q.8 You have said this is not only the biggest issue in Asia right now, but the biggest issue in global markets. Why is the technology arms race such a big deal?
MM: I think it's a big issue for markets because technology stocks are some of the biggest in the world now. If the trade war had to do with soybeans or steel and these companies in Asia go down 5 or 6%, you might not even notice it in the overall market. The reason technology is so important is because they're the drivers of the market and it's the biggest weight in a lot of markets now.
It's also because technology actually impacts our lives. If soybean prices go up, then it's really not going to make any difference in most people’s lives. But for Australians, for a lot of the people on my team who are Mandarin speakers, if WeChat gets banned in Australia, that makes a big difference. If Huawei gets banned across developed markets, that can actually make a big difference. I think that's why it's the most important thing for markets now, is because technology is what's driving it and anything that threatens people's certainty in tech leadership can have a big impact.
Q.9 Is there a reason why we can't two winners? There's often this concept of winner takes all, but does it have to be a zero-sum game?
MM: No, not at all. In fact, the splinternet may very well be where we're heading. This is why I like some of the domestic, mega-cap leader companies like Tencent, Alibaba and JD because they're going to be winners in that environment. The tech supply chain is probably the best example of why a siloed environment doesn't work very well because it would be very disruptive. It would be strange to have Apple but no Apple supply chain in the US. That's something that was explored in the early days of the Trump administration and they found your iPhone would cost $5,000 or something ridiculous like that. So, the supply chain is something which is not going to splinter, but e-commerce, internet, mobile, a lot of other sub-sectors in technology could certainly end up in separate silos.
Q.10 Let's stay on the sub-sectors. Talk me through the scorecard. What are the contested areas? And who's winning in which area?
MM: When Deng Xiaoping was the president, China had a ‘hide and bide strategy’, which meant hide your strengths and bide your time. And it was actually quite effective because China snuck up on the rest of the world in terms of its abilities in technology. A lot of people are surprised at where China is now. So, we have a list of different sub-sectors in tech and who's ahead China or the US.
I'd say in e-commerce, China is definitely ahead. Part of that is just because they have a bigger population, but if you look at GMV and certain aspects of penetration, I'd say China is ahead. Next is fintech where China is definitely ahead. Chinese fintech giant Ant is due to go public in what could be the biggest IPO of 2020. In green tech, I think China is ahead. Some people would say, "Come on. China has this reputation as being highly polluted. They can't possibly be ahead in green tech." But the investment in electronic vehicles and a lot of the things that go along with that puts China well ahead.
One area where the US is definitely still ahead is in AI. China has a strategy called AI 2030, which is their plan to be ahead by 2030. The fact that they're so upfront about that is telling you something. The US is definitely still ahead in military technology. However, this may be that we don't know where China is on military technology, but from what we know, the US appears to still be ahead. The US is also ahead on semiconductors. I think their biggest strength is that the US is ahead in terms of software for mobiles. Every phone in the world runs on Android or iOS and that includes every phone in China. It’s a big weakness on the Chinese technological landscape because if that was ever withdrawn, China would have big problems. That’s our scorecard in terms of who is ahead in the various sub-sectors.
Q.11: How are you choosing to invest in this? How are you placing your bets?
MM: We have a very defined process for how we pick stocks and a thematic is only one part of the process. For example, if technological disruption is the thematic then where they are in the tech arms race would be a sub-thematic of that. Ultimately, we're a growth fund so every stock has to meet growth criteria. Even if you're the most amazing, thematically based stock and you're going to win in the tech arms race, but right now you have no growth, then we're not going to invest in you. So, first and foremost, all companies, including tech, have to have high growth. Then there's an evaluation analysis. They have to have at least 50% upside in three years. We also look at industry structure because there are some stocks which may be winners from this technological arms race, but they have very bad industry structure. In this instance, a lot of the supply chain companies. If you're a supply chain company and 90% of your sales come from Huawei, that's not a good place to be.
We look at industry structure and then we look at thematic. And then we look at management and ESG. ESG is something which my funds take very, very seriously. This is not something we've come up with overnight because a lot of clients are asking for it. So, companies get scored on all those metrics. And then, if you come up with a high score, we do a deep dive analysis. The kinds of companies that pop up through this sort of analysis are obviously national champions. For example, Alibaba and Tencent, which are very well known to Australian investors, but they also meet our growth criteria. We have a preference for large cap for a number of reasons. Further, if you think of how China is very supportive of national champions in the technology industry. Whereas in the US you have congressional testimonies where a lot of lawmakers are going after big tech. So, if you're a big mega cap tech company in China and you meet our criteria, we like investing in those kinds of companies.
Q.12 Is the government support really that important?
MM: It is certainly better the government support is there and it's not against them. The Chinese government want these companies to succeed and that's a nice place to be. And generally, they are succeeding in that they have impressive management and very good execution. We also own stocks like Samsung SDI in Korea, which makes batteries for electric vehicles. Memory companies like Samsung and Hynix also meet our criteria. In India, as we've discussed, we like Reliance. There's a major scarcity value in India in terms of these new economy types of companies. Reliance now has a market cap of over $150 billion, which surprises a lot of people.
Q.13 Are there some of these big names where you've got more conviction than others or where you feel like the valuation has pushed through the levels that you are comfortable with?
MM: I have been very disciplined in taking profits. Naver, the Google of Korea, is an example of where we've taken profits. In terms of the big names, which people would know, maybe it's my economist hat being on, but I also look at who's the marginal seller and who's the marginal buyer. Right now, I see more marginal buyers in Alibaba than I do in Tencent. Alibaba was first listed as an ADR in the US. And then, because of political tension they have a secondary listing in Hong Kong right now. But up until a few days ago, it wasn't part of the Hang Seng Index and it is also not yet eligible for Connect. Southbound Connect means Mainland investors in China can buy your stock in Hong Kong. I think that there's a lot of marginal buyers because previously most people couldn't buy it as an ADR. It would be like Australians not being able to buy CBA and BHP. As soon as that that is allowed, you have 1.2 billion marginal buyers for Alibaba. Alibaba has also lagged JD and some of the other big tech companies. Alibaba is currently the largest position in our fund right now at about 10.7%.
Q.14 What's the next big thing going to be? Can you give us an example of a company in Asia that meets those growth criteria that you're looking for, but which people don't know?
MM: I'd like to push back on this question a little bit, because part of the reason we like large caps - and why our strategy is focused on large caps - is that in this sort of environment, if you're big it's easier to get bigger. It's much harder to be a startup and to be gaining market share. For this reason, I think that the next big thing is the current big thing. And that the next big thing to come out of Asia is actually going to be from within the big companies rather than some tiny startup that we've never heard of.
The next big thing could very well be Ant Financial, which is part of or affiliated with Alibaba. You can't buy it now, but that could be the next big thing once it lists. Or the next big thing might be Tencent TenPay, which is their payment system. Or it could be industrial internet things for Tencent. Or it could be Samsung coming out with a new kind of phone with some new sort of innovation. Also, if you look at some of the parts of these big cap tech companies, you can see that they are constantly on the lookout for the next big thing. Tencent is actually one of the biggest VC funds in the world, which a lot of people don't realise. And if you look at the number of VC investments that they make, I think they are third in the world. So, it’s reasonable to think that the next big thing is going to come out of that.
But to answer your question specifically, we like an Asia tech company called Hudson, which does software for financial companies, including Ant Financial. When you have a valuation for Ant Financial you can figure out who some of the suppliers are. Media Tek is one that we've held for a long time in Taiwan. It's actually doubled since we bought it and we've trimmed that position. I think in India there's going to be some interesting ones. These are not the next big thing, but some of these companies that have been around for decades like Infosys and TCS and they are at the forefront of digitisation. COVID19 has accelerated the move to digitalisation and things are moving much faster than anticipated. So Infosys, which five years ago people were saying was a boring IT services company, now has customers everywhere as every company in the world needs to digitise super-fast. And their stock price has been on an absolute tear.
Q.15: Finally, I like to ask investors about a lesson they had to learn the hard way. Perhaps a mistake that you've made along the way that you could share with us. And more importantly, tell us about the lesson that you took out of it?
MM: My worst mistake at Soros was to be short a stock, Household International. They got taken over by HSBC. And to be short and then get something taken over at a big premium is like the investor equivalent of getting kicked in the guts. It all just happens at once and it's terrible. So, that was my big takeaway from that, never short anything that's a target. Something that Robert Soros, who's George's son, said to me, which has literally stayed with me through my career, was "Most industries are about the income statement, but financials are about the balance sheet. So, forget about the income statement and become a forensic balance sheet analysis, and you will always be able to make money in financials."
And that has been a very good takeaway for me. In my fund now, even though I'm the PM, I'm still the financials analyst. And I've gone through every single financial that we own in Asia and said, “Okay, if COVID results in the worst NPL crisis, worse than GFC, do these companies need to recap and what do their balance sheets look like?” And it's been very informative in terms of how to invest in this sort of environment. So, that's not necessarily a mistake, but that's a big takeaway from Soros.
At Ellerston, I invested in a company which had a short seller report when I was working in the small cap fund. And it has instilled in me an absolute fear of short seller reports. It is one of the reasons why we have very, very strong ESG criteria in my funds, because I never, ever want any of the stocks that I own in that portfolio to be targeted by a short seller. A lot of the short sellers in Asia are kind of flaky and some of their reports are true and some of them are not. But sometimes it doesn't matter; the damage is done. A good takeaway is to make sure you're investing in high-quality companies with no warts and amazing governance, because it can ruin a whole year's worth of performance if you get hit by a short seller.
At Oaktree, I was working in an emerging markets fund. Tim Jensen, who was one of the portfolio managers, refused to invest in countries with current account deficits. His rationale was that you are always going to get screwed over on the currency. So he wouldn't touch South Africa, Turkey or some of these Eastern European countries, didn't like India. It was an extreme view, but over time it is not a bad view. So almost every country, with the exception of India, that I'm invested in, in Asia, has current account surpluses. A lot of Australian investors only have one country to invest in, and it is a very narrow way to invest. If you're running an emerging markets fund, you have twenty plus countries to think about. Even in Asia, we have thirteen countries to think about, so having a macro framework to think about which countries you like and which ones you don't has been helpful.
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