Market Review
The benchmark MSCI China index rose +20.9% in Euros during the first quarter of the calendar year.
China-US trade relations continue to be the main pace setter for global market sentiment, and it is noticeable that the Chinese have been redirecting imports from other suppliers to US sellers (e.g. soybeans). While a comprehensive trade agreement is still some way off, markets are no longer discounting the adverse cliff scenario.
In an important development, global index provider MSCI will take further steps for the inclusion of Chinese domestic equities in global indices, which further propelled on-shore equity markets in China.
Performance Review
Absolute performance was strong, driven primarily by a diverse group of thematic exposures in private education, the growth in traditional Chinese medicine, rising insurance penetration, and ecommerce. The fund lagged the MSCI China index. This is in part due to the extreme overweight of technology stocks in the MSCI index, with Tencent and Alibaba weighted at 15.0% and 13.5% respectively. As UCIT funds are limited at 10% for a single position, it is very difficult to match the index when market performance is led by these companies. This typically happens in a strong beta rally, such as the one this quarter. The fund lived through a similar scenario in the second half of 2017 just after the change in management, and successfully navigated the subsequent quarters.
Outlook and Strategy
Notably, the number of Hong Kong-listed firms that changed auditors has doubled compared to previous years, suggesting that the weaker economy of 2018 is starting to expose some of the more aggressive accounting choices. We have so far avoided major damage from an accounting fraud in the portfolio, underscoring the importance of fundamental research.
During the worst of the end 2018 gloom, we wrote constructively on how extreme levels of valuation would lead to an opportunity, and how both exuberant and extremely bearish description of China, its economy, the property market and its bank fail to capture the nuances.
This month, the IMF has upgraded its projections for China in its new World Economic Outlook, and we are happy to report that even the much maligned property market is showing signs of growth. Sales of excavators in March were double what they were two years ago, a sign of growth for the construction industry.
The recent improvements in Chinese manufacturing data (e.g. the Caixin survey) may indeed finally symbolize the effects of accommodative policy, yet it could also be a lag effect due to Chinese New Year in February. The data in the second quarter will thus be interesting to watch.