East Capital China

It was a relatively quiet quarter for China A-shares. Our fund returned -1.3%, 0.7% above the benchmark which returned -2.0%. Despite a brief rebound in late April due to regulatory support and bottom fishing, the market declined in late May, influenced by reduced expectations of Fed rate cuts, geopolitical tensions, and a slow economic recovery.

China's Q2 economic data presented mixed signals. GDP grew by 6.3% year-on-year, up from 4.5% in Q1 but below the 7.3% forecast. Retail sales rose by 3.1% in June, down from 12.7% in May, indicating a slowdown in consumer spending. Industrial output rose by 4.4%, up from 3.5%. Fixed asset investment grew by 3.8% in the first half year, down from 4.0%, suggesting a deceleration. Real estate investment fell by 20.6% year-on-year, with declines in sales and volumes.

As is typical for the market, local investors’ focus rapidly shifted, moving through equipment upgrades, real estate, high-dividend assets, and tech sectors. In April, equipment upgrades and synthetic biology were hot spots. In the post-May peak, sectors like coal, power, and the Apple supply chain gained strength. Value stocks prevailed, while growth stocks provided short-term opportunities. 

Our largest attributor was our large overweight, Zijin Mining, which produces copper and gold. The company returned 8% as copper prices rallied, up 25% YTD at its peak. Luxshare Precision, with iPhone/AirPod assembly as one business area, was another large attributer, up 30.3% as the market focussed on the improving outlook for Apple products.  

Our travels around China included the world’s largest solar fair in Shanghai, with 500,000 visitors, and visits to AI and tech companies. At the solar fair, we learned that industry oversupply is a persistent risk, suggesting it is prudent to avoid this sector despite rumours of consolidation. Our tech visits revealed companies striving to succeed without imported semiconductor equipment or Nvidia GPUs, highlighting unique industry localisation stories in China, which we are closely monitoring.

One of our main focuses during the quarter was a relaunch of the fund – the main change is that we are opening up the investment universe to allow us to also invest in offshore names; US and Hong Kong listed Chinese shares. The reason for this change is simple – we see that after several years of poor investor sentiment and relentless selling by international investors, Chinese stocks, particularly offshore, are trading at very attractive valuations and now paying generous dividend yields, despite solid earnings growth. The fund will aim to take advantage of this by investing in exciting but unloved companies across the Chinese investment universe, both onshore and offshore. The fund offers a uniquely strong combination of growth and value, with the model portfolio suggesting a PEG ratio (2024/2025 average) of 0.4x, compared to 1.4x for S&P 500.  The official relaunch of the fund will take place on 19 July 2024. 

Looking ahead, all eyes are on the Third Plenary Session in mid-July. We have heard widely varying views on what the government will focus on, though we expect an extension of the previous year of continuous drip-feeding of positive policy measures that will help to start addressing the economic malaise in the country, especially regarding the real estate sector. Our view is that such measures will start to have an effect and that in H2 2024, we are likely to see a stabilisation of the real estate sector, which should lead to improving consumer sentiment, a pick-up in economic activity, and potentially a more sustained rebound in stocks. However, the US presidential election will likely ensure that geopolitical noise will remain high and so it may not be smooth sailing.

Performance in USD net of fees.

The information should not be used as the sole basis for an investment. Please read the Prospectus and the KID, which are available on the fund page. This publication is not directed at you if we are prohibited by any law in any jurisdiction from making this information available to you and is not intended for any use that would be contrary to local laws or regulations. Every effort has been made to ensure the accuracy of the information, but it may be based on unaudited or unverified figures or sources.

On 8 October, Hong Kong equities suffered their worst single day since 2008, with double-digit percentage losses for the main indices, as the much-anticipated NDRC press conference provided little new detail on China's stimulus plans, leaving investors hoping for concrete numbers disappointed. However, while the A-share markets retreated from their opening strength, they still managed to close with gains on their first day back after the long National Day holiday. 
 
Our China fund, which has over 70% exposure to Hong Kong listed equities, was down 9%. Our initial positioning was more defensive. However, with the recent rally, many of the higher beta names are now larger than before. In the short term, we have reduced the weight of some of the higher beta names as we believe that this round of profit-taking could continue for a few more days. We remain cautious and will look to add to new positions as the market stabilises further. 
 
As for the "disappointing" NDRC meeting, we believe it was more of an excuse for many to take profits after such an aggressive rally.  We remain of the view that the government's stance of supporting the economic recovery and achieving the 5% GDP growth target is intact. Looking ahead, we expect more macro catalysts in the coming weeks, such as at the MoF meeting on 12 October, the Politburo and NPC Standing Committee meetings later this month or early November.