Market Review
The benchmark MSCI China index fell -10.1% in Euros during the fourth quarter of the calendar year.
It is too early for company earnings assessments as most portfolio companies will announce their full-year results in the coming few weeks after Chinese New Year in February, and we will be visiting portfolio companies in Hong Kong then. Apple had reported that more than 100% of its Q4 revenue decline occurred in Greater China, which added the perceived risk of a China slowdown to investors’ list of worries. Asian market fortunes have turned significantly to the positive as discussed in the outlook below.
Performance Review
While relative performance was on par with markets, negative absolute performance was driven by overall equity weakness in the region, however there were also a few single position specific drivers. For example, China healthcare shares, a key thematic focus given an ageing population, declined on government policy announcements seen as curbing profitability in the sector.
Outlook and Strategy
In December, the pace-setting US equity markets saw the highest weekly outflows from actively managed funds since 2000, resulting in the biggest monthly equity decline since the financial crisis. We had written in our Q3 review how emerging markets often trade to the extreme points of maximum pessimism or optimism, or even beyond that. Q4, and in particular December was certainly beyond such point, with Asian equities at historic lows, and the MSCI China price-to-book ratio less than 10% above its all-time low.
The widely reported Apple announcement contained an ominous sentence citing slowing growth in "government-reported GDP", hinting that actual growth is lower than reported. This perspective is not new, investors and economists have frequently doubted the accuracy of some of China’s statistics. None other than today’s prime minister Li Keqiang admitted as much many years ago, and recommended analysts to follow real economy indicators like electricity consumption. The long-term echo however is an extreme level of caution and suspicion when it comes to the assessment of China’s economy, with many Western analysts expecting an economic bust in China. High levels of debt and a property bubble are frequently cited. We disagree:
- The absolute level of debt in China at about 260% of GDP is in fact lower than in fully developed countries and mostly domestically held. We accept that the speed of the debt build up was unusually fast over the past ten years, and this is why we avoid Chinese banks as we believe there to be a long-lasting non-performing loan cycle. However, this is not necessarily a sufficient condition for a bust, with most debt domestic and not owed to foreigners.
- Property prices are up more than 500% over 10-15 years in cities like Shanghai, a dramatic number, but less so when compared to India’s tier 1 cities which experienced very similar price rises. Yet no analyst highlights the due implosion of the Indian economy, far from it, India trades at a more than a 100% premium to China. Also, a broader property index covering 70 cities has recorded a rise of only 40-60% over the past ten years.
In short, Hong Kong/China equities are very attractive on valuation grounds, because investors are partially pricing in a less than probable negative scenario. 2019 started very strong in Asia and in China, with strong reversals in performance, including the Nestor China fund. The key catalysts have been a softer tone in the US-China trade talks, a stop in the rise of the dollar, and flattening US rate hike expectations.
The fund sticks to its strategy of long-term thematic exposures, with a particular focus on smaller capitalization opportunities off the radar of mainstream investors.