Man: Welcome to the Center for Investment Excellence, a production of JPMorgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment teams.

Lesley Stiska: We've heard a lot about (China) recently and so let's just remind folks China is poised to become the world's biggest economy, really too big for investors to ignore going forward in terms of some of the world's largest equity and bond markets and yet investors are still woefully underexposed in China. Over the next hour or so we'll shed some light on what we are seeing in China equity markets and how it is impacting portfolio positioning.

To facilitate this discussion I'm going to pose some questions I have prepared for (Howard). So (Howard), thank you so much for joining us today. I know it's getting late for you in Hong Kong, so why don't we dive right in with some questions? Let's start with the market in China and what your experience has been over the past few months as China has gone through the pandemic.

Howard Wang: Yes. I think the experience I've had is actually similar to the news that has come out about the pandemic. So I think it began early in the year with reports of a pneumonia. The local authorities denied this was true because if there was something happening they said it was easily containable. And as a result of that, the market (unintelligible) quite well along with global markets at the beginning of the year and then it went into Chinese New Year.

And it was really during the Chinese New Year holiday that we started hearing more about the scale of what was happening and how contagious the virus was. Essentially, our markets were closed. Global markets pulled off. When our market reopened after Chinese New Year basically every stock was limit down which was 10% in China A.

At that point in time, I think the government came out with calls for a pretty coordinated fiscal and monetary response. So by the next day there was a rebound and then China essentially stabilized and it really only became a question mark again when we saw that the virus went global. In other words, I think if you trace the path of the average investment professional in China it kind of went through the ups and downs emotionally and market wise of what was happening with the virus and the amount of government support they put behind it.

I think which in the market though, there were very, very large divergencies and now we're really just talking about index levels. And we can get through some of that. But in very stark terms, essentially companies that could grow despite the state of the overall economy, i.e. companies that were growth companies and not necessarily very cyclical; companies that had things to do with digitalization, software; companies that had something to do with healthcare; companies that had something to do with electric vehicle future, 5G infrastructure. All of these kinds of stocks in China actually went up. Some went up quite a bit.

And this had something to do with the big, broad economic cycle, whether it's banks, commodities, construction companies and the like actually went down quite a bit. Underneath the surface of the market that went down pretty sharply and it kind of rebounded from there, there was just a lot of divergence in sector performance. Much of it is really to do with how investors were thinking about the impact of the virus on various subsectors over the longer-term. And also really basing it in the reality that rates might be lower for longer, not only in China but on the global basis as a result of the devastation caused by the pandemic.

Lesley Stiska: A real divergence in terms of sector performance during this time period. When you think about your investment process and the recent changes that we've seen in the market and the (monetary) fiscal stimulus that's taken place in China and really the rest of the world, has it impacted your investment process at all?

Howard Wang: The short answer is no. Because the (unintelligible) investment process is basically built on a few research pillars. The first one is what we call strategic classification and that's thinking about companies within the context of their industry over a longer-term. Think about structural changes that could happen in industries, think about secular trends underlying demand for the corporate side and on the consumer side. And that really provides a qualitative foundation for the kinds of companies we want to invest in. And that's relevant in every type of circumstance, trying to buy the best businesses that generate high resurgence on capital and then deliver that return to shareholders over time.

The second pillar we tend to look at is we think about valuation on a longer-term basis. So in other words, when we go into a situation like we are in right now where there is a massive shock that results over a short period of time. But hopefully, we rebound as we get into year two, year three, year four after the virus. This is the way our valuation (unintelligible) so in some ways our evaluation process is well-adapted to situations like we're seeing right now, which is essentially the equivalent of a national disaster.

And then the third pillar that we built our process on is what we call risk profile analysis and thinking about environmental social governance issues or companies over a period of time. And a lot of these kinds of questions focus on sustainability of the business, its ability to weather downturn, for instance, the one we're in right now; the ability for a company to basically deliver great outcomes for the broader society that it's part of. That's also quite relevant.

What we really focus on is strong businesses that will do well over time, teach our shareholders the right way, our communities the right way. And as a result of that, we think it's an all-weather process and it's a process that we really hold onto and really come back to during periods like this. Thus far, I think the returns in our strategies have been pretty satisfactory as a result of this which gives us even more confidence that staying with what we know and the way that we look at companies in the industry is the right thing to do even though there's so much happening around us in terms of the economic cycle and in terms of politics and the like.

Lesley Stiska: Great. Thank you. You mentioned before some of the winners in this situation were digitalization, healthcare, electric vehicles and 5G. Can you elaborate on that a little bit? And on the flip side of that can you just talk about some of the risks that you're seeing; what's keeping you up at night as you evaluate opportunities for this portfolio?

Howard Wang: That's a lot. But first of all, on the opportunity side when we think about the second portfolio and I represent the growth part of our book of business, we usually think in terms of big subsectors with strong underlying growth trends. And roughly speaking, they fall under three really broad thematic (sectors). One is the healthcare opportunity in China. The second is the technology opportunity in China. And the third one is the consumer opportunity in China. Because really I think right now when we think about all three of those we think about the first two principally as things that will do well structurally.

And because of the virus, what's happened is that a lot of demand that we were forecasting several years in the future, was essentially brought forward. So for instance, we have positions in companies that are involved in vaccinations and diagnostics and in testing within the healthcare space. All of these are companies where we looked at them and we said well, let's include vaccination. In China the number of (unintelligible) has been like 4% to 6% (unintelligible) counted.

The number of (offices) in the United States is much, much higher, over half the population. Originally our thesis was well, China over time will see an inching up as awareness grows, about flu vaccination and how valuable of a thing it is, for everybody, even if you pay out of pocket. Obviously I think now we're in a situation where awareness of what this can do and whether for an individual in terms of keeping your health and keeping you away from the hospital, or from a public health standpoint, i.e. keeping people who do not need to be in a doctor or in a hospital away from here, because if you get a vaccination, has become much more important.

These kinds of healthcare trends are ones where we saw a penetration might have been call it 15% five years from now and all of a sudden it could be 15% next year and it could be 40% five years from now. With healthcare, broadly speaking we see a lot of opportunities like that. On the technology side, we've invested in companies that for instance, provide kind of a version of Microsoft Office but it's given away essentially free in China. They can subscribe for extra features and to get rid of advertising like we do with apps from the Apple app store.

We've invested in a lot of companies that have something to do with digitalization of analog businesses. And then again, these are things where recent events have brought forward future demands. China is trying to use its own operating system much more because the United States may prevent its domestic producers from giving China technology. But it's been kind of also when we look at something like digitalization there's a current need that's grown a lot and then the future need actually has grown quite a bit also because people realize it's important for companies to be able to automate and say the process is impossible for company management to have a lot of information at their fingertips to be able to analyze it.

It's important for people to be able to work from home or work from the road in a very effective way. Again, I think within tax and especially within the technology parts of our China (unintelligible) with a digitalization focus. There is a future opportunity that was brou9ght forward to the present time and the future opportunity is a lot bigger than you probably thought it was or hoping it would be.

And then finally, within consumer I think it's much more nichy and I would say that consumer right now is pretty well-trodden. And so a lot of these producers that also are analogous to the healthcare and (unintelligible) companies where the current situation benefits in some way and that will change behavior for their consumers over a longer period of time. Taking a step back and kind of summing up, we probably see the best opportunities in healthcare and tech right now, particularly in healthcare and diagnostics testing and services in tech in the software space broadly speaking.

And then we see some niche consumer opportunity also, although I think from a longer-term standpoint and particularly the near term there might be an upcycle that we'll talk about a little bit later how the Chinese consumer is doing where there might be a little bit of a cyclical balance. We also see technical opportunities to consumer. Overall, there are a lot of things to be excited about.

Now on the risk side I think the principal things are reasonably straightforward. Number one, I think China went into the virus and (unintelligible) program thinking that the virus would be the equivalent of a heart attack and that the patient would be resuscitated with a V-shaped recovery. I think what China did not do successfully was the possibility that the virus (unintelligible). We do worry about the longer-term damage that could be done to economies all over the world or what that would mean for China's export and manufacturing businesses.

I think the second thing that's happened which has already got a lot of headlines of late, is China's foreign policy in the geopolitical environment, the function might have just gotten a lot, lot worse. It's had its bad moments. The phase one treaty was signed with the United States it looked like things were at the very least, stabilizing but now it looks like (unintelligible) geopolitics is on our mind in terms of sanctions, tariffs and other breakdowns or disorderly breakdowns in the way that the US and China economies are linked. We do worry about these two things.

And finally, I think from an overall standpoint we do worry a little bit about valuation because there have been values of a lot of the types of stocks that we like to look at in terms of the growth areas in China. We do worry that the average investor might be a little bit more short term and something you can look at if you look at one year PE, etc. And then we make a little bit of a valuation correction.

But you are (unintelligible) more typical in nature whereas export demand is possibly a serious cyclical issue and the second issue is geopolitics and the way that things work out between the US and China. That could be a structural issue that could create a new set of winners and losers within China. But overall, we think China as an economy, a bit of a loser, just like I think the global economy is a bit of a loser if the US and China decouple.

Lesley Stiska: Great. Thanks for the summary there. You mentioned valuations. Can you just talk about where you're seeing valuations currently, how you're valuing companies and were they stressed before entering into the economic shutdown?

Howard Wang: Sure. Going into the shutdown we looked at valuations using our five-year expected return that I talked about before when I was talking about our process. And roughly speaking, going into the serious part of the shutdown, so after the markets fell that first (unintelligible) the Chinese New Year holiday we were starting to look at China and the MSCI China valuation, call it in the mid to high teens. Now we're seeing - particularly I think with China we've seen a bit of a rally since then so now within our coverage universe see something that's much more in the mid-teens, about 13% or thereabouts.

And our five-year (unintelligible) MSCI channel we have 15% given that those markets whether it's US/China ADRs or probably even more damaging, like what's happened to a lot of the cyclicals within Hong Kong that are China companies, that's why there's probably about a 15% expected return. The way we look at valuations is really with that metric in mind, particularly for a growth investor as I mentioned (unintelligible). Companies in healthcare or software that might take some losses upfront and make a lot of money later on, or right now broadly speaking, there are a lot of companies in the (unintelligible) taking a loss and then will make money later on.

It also allows us to think about what possibilities in terms of like on a normalized basis and that's really (unintelligible) the foundation of the way we think about valuation. So as a whole, I would look at it, I think the market is (unintelligible). When we think about emerging markets in Asia-Pacific, the broader team that I'm a part of, we can find other markets that are cheaper, but we probably can't find a market with so many idiosyncratic micro-level opportunities like there are in China just given the vast size of the market and the fact that when you look at China onshore, the market is 80%, 90% any given day, is the turnover comes from retail.

So there are also just a lot of opportunities that come up for investors who are a little bit more patient. In other words, I think when we think about that 13% number that's actually not a bad 13% number because when we scratch underneath that we can find very high probability (10)s and we can find very attractively (20)s within that 13% aggregate number for China A.

Lesley Stiska: And that 13% is your five-year expected return forecast that's derived bottom up from the analysts that are looking at the companies?

Howard Wang: Yes. That's right. We are basically summing up those forecasts. And roughly speaking, the way we do it sounds quite sophisticated. It really is what PE do you take going in, what PE do you get coming out in year five, dividends, the FX backed US dollars and then of course the foundation for returns is (unintelligible) within five years. It's a pretty simple formula that we're using but we're finding (unintelligible) our company and then you're summing it up into that 13% as opposed to deriving the 13% top down.

Lesley Stiska: Got it. Thanks. More broadly, as US investors as I said at the beginning, people are pretty under-allocated currently to China, how should we be thinking about allocating to China? How big of a portion could it be of the overall market? Obviously inclusion is increasing in the MSCI emerging market indices. How should we be thinking about a dedicated China (fleet) for our investors?

Howard Wang: Well I think the very raw numbers say that within emerging markets if China goes in at a totally included (weight) without MSCI scaling it back, it can represent over 40% of the index fairly easily. And that's excluding all of the IPOs. There are a lot of big companies in China that just haven't even listed yet. For instance, (unintelligible), the people behind (unintelligible). That's a $100 billion company. That's a piece of (unintelligible) of influence put together.

So in other words, markets actually grow, push through new listings and through earnings growth, et cetera. So China becomes a very, very meaningful portion of the emerging universe. I guess if I were sending this here to someone who was looking at an EM manager, thinking about what do I need to carve out China, I guess the question really is, is the EM manager prepared to research China the way that China needs to be researched since I think we need to remember, the average domestic fund manager who is in kind of a top 20, top 30, top 40 fund manager, these places have call it 15, 20, 30, up to 50 dedicated research analysts looking at fundamental equities in China.

That is the competition when we think about market efficiency. The question really is, is can the emerging market manager have that resource team to compete over the longer-term, against people like that? Because I think over the last two or three years it was quite easy to buy the first call it 20 names that come to mind in China for instance. And you did very, very well. Those are great companies - (unintelligible) the liquor manufacturer, there are some great technology companies, there's one really good pharma company that everybody holds. These stocks have done spectacularly well.

But when we look forward three to five years in terms of generating alpha you really need to get down into the weeds, understand the midcaps in China and the question I think really is, for allocating is, is your EM manager prepared to deliver that for you? And probably I think for instance, what helps at JPMorgan is we'll say hey, we're able to do that; we actually have that much in terms of resourcing on the ground. Not every emerging manager, even great ones, have that kind of resourcing.

And that's fine right now, but the (China) universe is ten or 20 (unintelligible) plus Alibaba. But the way the (China) universe might look in three to five years is going to get much bigger in index and it gets much more complex and difficult to outperform other people. That's really a question I think of structural resourcing because you need to have a lot of people looking at it and there's also a language barrier. Because the people looking at it will need to be able to read and write Chinese and preferably, you'll have people who are representing (unintelligible) in China.

Because in terms of predicting consumer demand, thinking about government activity, etc., it always helps to have people who are just really grassroots from there. So really I think speaking as somebody who is basically (unintelligible) that's probably the way I would think about emerging managers and whether one would need to think about China separately. Can they deliver that type of solution and bringing in the whole market and the whole economy?

Lesley Stiska: Going back to the trade war between US and China, there's been a lot of talk about supply chain shifting back to domestic markets, not just in the US but elsewhere. And it seems that that has intensified again recently. What's your view of the likelihood that this will occur and who would be some of the winners and losers if it does?

Howard Wang: Let me try to answer that question a couple of different ways. First, from a self-sufficiency standpoint, things like medical equipment and (unintelligible) necessity, I think there's a 100% chance. I happened to be on a panel a couple of weeks ago, we had a couple of prominent economists. One was (Penny Goldberg) who used to sit at the World Bank and was also (unintelligible) Economic Advisors. And just talking through countries and regions around the world.

And this is a universal trend that having gone through this pandemic, countries with the ability or with the capacity to do it, would want to be able to produce a lot of their own medical equipment regions use in medical testing of other kinds of mission-critical goods for the economy. So there's no question that everybody will want to move farther towards self-sufficiency.

But in terms of kind of the broader picture I think that you're referencing that the US and China has supply chain outside of this necessity. I think that there was - I don't want to call it decoupling but it was already a shift away from China prior to the Trump Administration, prior to the trade war, and that was a very natural economic shift because China just got accepted. Because a lot of the things that we are talking about - sophistication, Chinese corporates are ready for software, consumers are becoming much more sophisticated, this is a result of the average income in China having gone up a lot over the last few years.

The currency appreciating from back when it was 6 to where it is now, a reasonable amount as well. In other words, China's got more expensive because it became much more developed. And so because of that the supply chain has already been shifted. For instance, in our broader offshore China portfolios we own shares of the company that is the biggest (and best) textile player in the region, possibly in the world; the outsourcing. The upstream supplier for some people like Nike and Adidas.

And this company has already shifted half of its production out of China where it was (unintelligible) China into Southeast Asia. So it's got a big plant in Vietnam and it also has capacity for instance in Cambodia. So this has already been happening in the same way that Japan kind of gave way to Taiwan, Taiwan gave way to China, China is already giving way to Southeast Asia. It's also a company that globalized footprints because of the way the tariffs are set up.

So for instance, we own a company in Taiwan that makes servers as well as (unintelligible) significant capacity in places like Mexico because of the tariff regime there as a result of the old NAFTA and the US (MCA). I think what's basically happened is similar to the way the pandemic magnifies accelerated search in terms we saw at a micro level, the Trump Administration and the US/China trade war essentially (unintelligible) the supply chain (technically) already happened.

They said that China was already giving up things because it wasn't the lowest (cost) location anymore. That's (unintelligible) because the tariffs basically effectively are increasing the costs plus there's also the (unintelligible) and the need for China to become more self-sufficient on certain things were you to depend on global supply chain. So I think we'll probably see a lot more especially around the portfolio, with tech manufacturing in China both around this.

What does China need to become self-sufficient? Where does China have the capability to be self-sufficient? Where you have a company that is able to produce something at a profit and not just produce a lot of substandards (created) at a loss. So this is something that's already been happening. It's accelerated and it's something that's already informing our investment thinking.

Lesley Stiska: Okay, great. Well (Howard), thank you so much for your time today. We know it's getting late there and you're hopefully going to head off to dinner with the family or at least a bedtime story. We appreciate everybody for joining in today. And if you have any questions or would like any additional information on what we discussed, please reach out to your JPMorgan client advisor.

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