Posted inChina

Schroders turns cautious towards China stocks

The firm’s China mixed-asset product has slightly trimmed down its equity allocation.
Ricky Tang, Schroders

Chinese equities have performed well so far this year, offering investors double-digit returns, with the MSCI China Index and CSI 300 Index returning 15.85% and 16.1%, respectively, according to data from FE Fundinfo.

The positive performance is supported by the optimism of investors over China’s improving economy, which has quickly rebounded following the disruption of the Covid-19 pandemic, according to Ricky Tang, Hong Kong-based deputy head of multi-asset for North Asia at Schroders.

However, while the recovery of China’s stock markets has been “impressive” since the March sell-off, investors should be cautious of valuations, Tang told FSA.

“In terms of equities, we still have a slight overweight exposure [in our China mixed-asset fund]. But we used to be more overweight especially in April right after the market sell-off when we saw some bargain deals,” he said.

Right after March, the Schroder China Asset Income Fund, which is led by Patrick Brenner, had around 57% of its assets in China equities (a neutral allocation toward the asset class is 50%), according to Tang. Recently, that position has been slightly trimmed to around 53-54%.

Tang explained that the share prices of some companies, particularly within internet and e-commerce space, have continued to go up despite some of them already lowering down earnings growth estimates in the next five years.

“It seems a little bit excessive from our perspective, and those are the names that we will probably take profit for now,” he said. That said, he believes that some names are expected to provide strong earnings in the next two-three years, which the fund will continue to hold.

“It doesn’t mean we have completely given up on the sector. We still find some good, long-structural winners, which are relatively cheaper.”

On the other hand, Tang is seeing more value in the more traditional sectors, such as financial, materials and industrial companies, especially on the back of the expected normalisation of China’s economy.

“We see more interesting opportunities now in some of the traditional sectors, which have been beaten up quite badly over the last couple of months because the rally has been concentrated in internet and e-commerce stocks.”

In addition to expensive valuations, other risks loom around the asset class, including geopolitical risks between China and the US, as well as the upcoming US election.

“In the coming months, we think that volatility can come back. That is why we want to take a pause in our large overweight and want to be more tactical in managing the positions,” he said.

Fixed income

On the fixed income front, Tang is positive over China bonds. On the corporate front, he favours the real estate sector.

“We see quite a lot of issuance over the last couple of months in the sector, and those are quite attractive from a yield perspective,” he said.

Real estate bonds make up the highest allocation within the fund’s fixed income sleeve, accounting for 11% of the overall portfolio as of the end of July, according to its fund factsheet.

Within the government bond space, Tang prefers offshore US dollar-denominated bonds over onshore renminbi bonds.

“The yields are higher in onshore bonds, but we believe that when volatility comes back, US dollar duration comes with better protection versus onshore duration. Yield spreads are also quite tight in the onshore market. From our perspective, they are actually quite expensive,” he said.

Overall, onshore bonds only account for 11.2% of the fund’s portfolio, which compares with the 24.8% allocation in offshore Chinese bonds, the fund factsheet shows.

The Schroder China Asset Income Fund – sector allocation (%)

Source: Fund factsheet. Source: Fund factsheet. As of end-July 2020.

Distribution opportunities

The Schroder China Asset Income Fund, which is a Hong Kong-domiciled fund launched in 2016 and has HK$3.6bn ($460m) in assets, is currently only available to investors Hong Kong.

While the fund is only distributed in the SAR, the firm is exploring ways on how to offer the product in other markets, according to Tang.

“We are trying to explore the possibility of launching a Ucits or other versions of the fund, depending on the demand of the strategy,” he said.

However, it is not easy for the firm to replicate the fund’s strategy, given that there are some investment limitations in certain jurisdictions. For example, in Taiwan, a retail fund is only allowed to invest up to 20% of its assets in Chinese onshore assets, including A-shares and onshore bonds, according to Tang. The same applies to the China-Hong Kong Mutual Recognition Fund (MRF) scheme, where northbound MRF products also have a limit on onshore assets.

Another option is distributing the fund via the highly anticipated Greater Bay Area Wealth Management Connect scheme.

“While we do not know the exact details of the scheme, hopefully it may include Hong Kong-domiciled funds. If it does, we could possibly distribute the fund in the GBA if we could see demand for this strategy.

The Schroder China Asset Income Fund versus its sector in Hong Kong

Source: FE Fundinfo. In US dollars. Note: the fund does not have a benchmark index.

Part of the Mark Allen Group.