Market Review
The benchmark MSCI China index rose +1.0% in Euros during the second quarter of the calendar year.
Euro-strength has reversed to Euro-weakness during the quarter, providing a welcome respite for Euro-based investors that had suffered from translation headwinds earlier in the year. Across asset classes however, emerging markets have trended down this calendar year while developed country equity markets flatlined. This follows several steps of escalation in the global trade war.
NESTOR portfolio companies again saw a positive trend in revenue and earnings announcements for the latest quarterly reporting. However most Hong Kong-listed names are reporting on a semi-annual basis, so this coming August/September earnings season will be more interesting for the fund.
Performance Review
The NESTOR China fund concludes its June 17/18 financial year, the first under new management, with a performance of +21.0%, strongly outperforming its MSCI China benchmark at +16.7%.
In the past quarter positive performance contributions were made by Chinese middle class consumption, but notably also ageing/healthcare related themes. The strongest contribution came from Minsheng Education. Detractors were a combination of past winners ceding some P&L and deterioration for some manufacturing names.
For the past twelve months, positive contributions came from across the thematic spectrum including middle class consumption, ageing/healthcare, infrastructure, technology supply chains, and education. The major detractors were investments in manufacturing companies within the “multi country supply chain” with the majority of the loss suffered in the second half of last year. The fund still holds a position in some of these names as we expect a long-term reversal.
Outlook and Strategy
The Chinese Yuan currency has given up virtually all its year to date gains on both a trade-weighted and US dollar basis during the month of June. In combination with a more than 20% fall in domestic share prices in China, some media are wondering whether we are seeing a repeat of the devaluations and credit scare of 2015/2016. We disagree, primarily because domestic profitability remains strong, and because there are no signs of capital flight, with foreign reserves stable and rising, and exporters steadfastly converting proceeds back into local currency.
Trade disputes triggered by US rhetoric have over the past few weeks turned into outright trade wars, with tariffs and retaliatory tariffs imposed in the US-EU and US-China trading relationship. These are undoubtedly negative news, however our medium-term scenario remains one of re-routed rather than cancelled trade, e.g. certain Chinese exports will travel via Vietnam or Malaysia now. Within our portfolio, there has been surprisingly little bifurcation in individual share performance, and regional markets have sold off on overall capital outflows somewhat indiscriminately. We expect stock selection to matter more strongly this coming quarter. The portfolio remains strongly focused on domestic demand themes.