East Capital China

China had one of its best quarters in years, with the MSCI China All Shares Index returning 23.6%. Much of the positive performance came in the last few days, thanks to the government's policy announcement on stimulating economic recovery. Q3 was also a great quarter for our China fund, which returned 27.9%, generating 4.3% alpha over the benchmark. 

In terms of the market, the Chinese government somewhat unexpectedly announced a broad and coordinated policy response to the country's well-documented economic problems in late September. This marked a significant and unexpected shift from the previous approach of drip-feeding small policy changes on a piecemeal basis. Everything started on 24 September, when the heads of all the financial regulators held a joint press conference announcing a series of positive measures. This included reserve and interest rate cuts, which should release USD 142bn into the economy, changes to down payment rules and two new tools to boost capital markets. The first tool is a USD 71billion programme to allow funds, insurers and brokers to pledge shares (as long as they return the money to the stock market), and the second provides up to USD 43 billion in cheap loans to commercial banks to help them finance share purchases and buybacks by other companies. Two days later, the Politburo’s meeting issued a strongly-worded set of policy directives. Most notably, these included calling for increased government spending through borrowing, “forceful rate cuts” and “stopping the decline of the housing market”. Press reports the same day suggested the government was considering some USD 140 billion or more in loans to boost consumption, and the same amount to recapitalise local banks. This is the kind of cash injection that economists have long been calling for to really start turning the economy around.  

Much of the performance was driven by aggressive short covering, as China sentiment was extremely poor ahead of this, and further driven by a wave of optimism amongst Chinese retail investors trying to invest ahead of the Golden Week holidays. Brokers had to remain open 24 hours a day to deal with the influx of new investors, and onshore trading volumes (Shanghai and Shenzhen) hit an all-time high of USD 370bn traded on 30 September. 

The question, of course, is whether this rally can continue. We remain cautiously optimistic, as we believe the government can and will follow through on the fiscal/demand side stimulus – likely in the next few weeks. We note that this isn't something China is completely averse to; we recall the 2008-09 stimulus package, which drove GDP growth to 10%. We also note that the market is still below highs of even 2023 and still 41% below 2021 highs with valuations still well below historical averages. However, we do believe that the market will need to see concrete evidence of this fiscal package ahead of another significant leg-up. 

In July, we adjusted the investment strategy of the fund from an A-shares fund to an All-China fund. This change came about as we want to tap into a broader investment universe and maximise our opportunities in terms of portfolio allocation, as there are attractive H-shares (Hong Kong-listed Chinese shares) and US listed Chinese shares in addition to the A-shares. Performance has been in the first quartile of peers since this time, with August alpha of 2.7% and September alpha of 2.0%. This highlights our robust investment process and active management style, which is particularly important during periods of market volatility, when sentiment and momentum can shift rapidly.   

One of the major trades was to increase the beta of our Chinese names as discussed, for example adding to Alibaba in late August. Partly because they were about to be added to the Stock Connect program, which means that for the first time, local Chinese investors could invest in the stock. 

Looking ahead, there are two key events and risks that we would monitor. Firstly, the stock market has rallied on expectations of additional fiscal stimulus from a potential RMB 2-3 trillion package, which is yet to be confirmed and is likely to be discussed at the NPC Standing Committee meeting in late October or early November. This needs to be monitored as to how the funds are deployed and their economic impact. Secondly, the US election could impact China's stock market, especially if Donald Trump wins and imposes higher tariffs on China, which could disrupt supply chains and impact China's growth.

Performance in USD net of fees.

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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.