China A-shares push through headwinds

Asset Class in Focus

Despite a wide range of destabilising macro troubles, Chinese domestic shares are well-supported by structural growth and official policies.

Eric Bian, JP Morgan Asset Management

“The China stock market started the year strongly as part of the global equity recovery on the back of a more dovish Federal Reserve,” Eric Bian, investment specialist, emerging markets and Asia Pacific equities at JP Morgan Asset Management told FSA.

Meanwhile, passive China-focused exchange traded funds are among the bestselling products launched in Asia during the past year.

However, it is not difficult for investors to find reasons to justify a pessimistic attitude towards China equity markets. They can easily compile a laundry list of anxieties.

There is China’s escalating trade dispute with the US and slowing domestic economic growth. The currency is on a depreciating trend and there is a structural decline in the country’s current account balance. There has been a pick up in onshore corporate bond defaults and there are rising concerns (again) about the shakiness of its shadow banking system.

If that litany of worries weren’t enough, then there is the elevation of political risk should Beijing physically intervene to quell the three-month long popular street protests in Hong Kong.

So it is perhaps surprising that China stocks have performed so well this year. They have not just held their own compared with other major markets, they have outstripped them.

The CSI China 300 index of the country’s largest and most liquid stocks listed on the Shanghai or Shenzhen exchanges has generated 25.14% return in US dollar terms for the year-to-date, according to FE Analytics data.

Its performance far exceeds the MSCI Emerging Markets index (3.14%), the MSCI World index (12.65%) and the S&P 500 index (16.60%). Meanwhile, Hong Kong’s benchmark Hang Seng index has crept up a mere 4.58% this year, which indicates that investors are blinkered neither to the economic impact of China’s tariff war nor the political effects of the civil disobedience in its SAR territory.

“China A-shares have been performing resiliently largely due to supportive policy in the background,” explained Bian.

“The authorities have started to implement meaningful fiscal and monetary measures to stabilise the economy, including cutting bank reserve requirements and reducing VAT in the first half of the year. We expect more to follow.”

Funds boost

Bian also attributed to the strong A-share performance to the decision of the MSCI to raise the inclusion factor for newly-added A-shares in its emerging market index throughout this year – which explains why the CSI 300 index (composed of A-shares) has far outperformed the MSCI China index (6.03%), which is dominated by Chinese companies listed offshore.

Bian is an investment specialist contributing to JP Morgan’s China equity funds, including the firm’s China Pioneer and China A-Share Opportunities funds, which are two of the top three performing funds among SFC-authorised China equity funds so far this year, generating returns of 34.12% and 34% respectively.

“Sector and stock decisions have both been contributing to relative returns,” he said.

“An overweight in the consumer staples sector has been the standout, and performance has also benefited from longstanding underweights in the materials and energy sectors, neither of which suit our preferred approach of investing in domestic structural growth stories.

“Some of our core holdings with structural growth opportunities were among the most significant contributors, notably in the IT and consumer space,” he added.

Both funds have also outperformed the sector and the CSI 300 index over three years, with the China Pioneer A-Share Fund achieving a cumulative return of 28.48% and the China A-Share Opportunities Fund a cumulative return of 26.92%, compared with 16.64% by the sector and 14.18% by the index, according to FE Analytics data.

However, both funds have been more unstable over the period, with annualised volatilities of nearly 21%, two percentage points higher than the index and three-and-a-half percentage points more than the sector average.

For the time being, Bian remains optimistic about the future.

“With the China-US trade talks still ongoing, policy makers are likely to maintain a benign liquidity environment and provide fiscal support where needed,” he said.

“In terms of portfolio positioning, our structural overweight in consumer, healthcare, and technology stocks remain unchanged and we continue to focus on secular growth companies with a tilt towards domestic centric businesses and high earnings visibility.”

However, Bian warned that “given the bias towards growth and quality as the investment style, the funds will likely underperform at market inflection points when cyclical value rallies or there are risk-off corrections.

“In contrast, the fund will be likely outperform when company-specific factors are the main drivers of returns,” he said.


JP Morgan China Pioneer A-Share Fund vs the benchmark and sector average

Source: FE Analytics. Returns in US dollars, year-to-28 August 2019.

 

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