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Investing in ‘New’ China
The Chinese Year of the Rooster begins on 28 January with investors still awaiting a new dawn in the country’s multi-decade growth story.
The transition from an export-driven to a consumer-driven economy is resulting in slower growth and the Shanghai Composite index is yet to recover from the big corrections in August 2015 and January 2016 as jitters over a hard landing for the economy reached fever pitch.
Against this backdrop, portfolio manager Howard Wang and the rest of the team behind the JPMorgan Chinese Investment Trust (JMC) are looking to deliver nuanced exposure to China. One of only two pure Chinese investment trusts listed in London alongside Fidelity China Special Situations (FCSS), both have delivered share price gains in excess of 30% over the past year. JP Morgan’s fund trades at a 13.9% discount to a net asset value of 234p and Fidelity’s trust trades at a similar discount.
JPMorgan Chinese Investment Trust (JMC) 201.4p
Estimated NAV: 234p
5-year total return: 76.5%
New China focus
Wang says: ‘Our focus is to find businesses well-positioned for China’s economic evolution with the divergence between the old and the new and how it will shape up to be in the next three to five years, across market capitalisation and across market listings.’
Wang explains that the fund has the flexibility to invest in stocks which are not classified as Chinese by MSCI but nonetheless earn a significant proportion of their revenue from the country. He cites the example of Taiwanese smartphone component makers, adding: ‘They have made a meaningful contribution to our portfolio returns over the last several years but would not have been available as investment ideas in a pure China fund.’
He adds: ‘As our investment professionals are located on the ground, the deeper access to local companies should play to the strength of a closed-end investment trust vehicle which can invest further down the market cap spectrum, in businesses less well known and discovered by others, with relatively less liquidity constraints.’
The portfolio is concentrated in what Wang describes as ‘New China economies’ including areas such as consumers, healthcare, technology and the internet and environmental services. On the consumer side the trust holds stakes in a variety of businesses in media, tourism, automobiles and kitchen appliances.
A position in travel services provider Ctrip (CTRP:NDQ) plays to growth in domestic leisure travel and there are substantial positions in big online businesses like Tencent (0700:HKG) and Alibaba (BABA:NYSE).
Wang adds: ‘We also found a niche player that specialises in kitchen range hoods (Hangzhou Robam Appliances (002508:SHE)), distinctively tailored for the Chinese consumer, with high barriers to entry in their business model.’
‘The healthcare sector should experience structural growth supported by healthcare spend and demographics,’ he adds. ‘Within this space, we are also selective about the companies that we believe are positioned to be the long-term winners, including a hospital operator and successful research and development drug companies.’
As of 30 September 2016, around 12.5% of the trust’s value was concentrated in China’s domestic A-Shares, with the majority in Hong Kong and US-listed stocks, but Wang says that proportion could grow over time.
‘Overall, given the improving access to the onshore China markets, which we believe will increasingly offer the type of companies that fit our investment criteria, we may look to increase our exposure to A-share companies.’
The plan is to avoid undue exposure to macro trends through a long-term approach built on bottom-up stock picking. Stock selection is expected to contribute between 75% and 80% of the relative performance with sector allocation accounting for the rest.
Wang acknowledges there are inherent challenges associated with investing in China. ‘Corporate governance in China remains a work in progress and certainly as a whole does not compare to developed market standards, and so we are thorough and thoughtful in looking for quality operators, companies that are well-managed with a solid balance sheet and where we have visibility into their capital allocation strategies,’ he says.
The Chinese economy has been piling up debt in an attempt to keep the economy growing and the private debt to GDP ratio has spiralled to more than 200%. For Wang this is more of a worry on the growth side than the credit side, given most of this borrowing is contained within a relatively closed system. However it is also not an issue he sees going away in the near future.
‘China is still unfortunately a credit-driven economy given the governmental focus on growth so while we expect a moderation in leverage levels, we don’t expect this overhang to dissipate any time soon.’
More positively, Wang highlights several steps forward over the last 18 months in China’s capital markets. These includes the long-awaited launch of the Shenzhen-Hong Kong Connect program on 5 December 2016.
‘This latest scheme provides yet another way to access the more liquid and more diversified onshore China markets, which, coupled with what we believe to be the eventual inclusion of China A-shares into MSCI indices, should further investors’ participation in the evolving economic growth of New China,’ Wang concludes.