China watchers have had little to lift their spirits in 2023. An underwhelming market rebound following the lifting of post-Covid restrictions has been compounded by persistent weakness in the Chinese real estate market, as well as US/Chinese tensions – dealing a painful blow to consumer investment confidence in the process.
Nonetheless, as Simmy Qi, Shanghai-based portfolio manager on the JPMorgan China Growth & Income (JCGI) investment trust team, observes, in daily life much of the Chinese economy is thriving as people return to the travel and cultural events they enjoyed before the pandemic.
“In many sectors demand is well above pre-Covid levels, though some areas of discretionary consumer demand are more sluggish, whether because people stockpiled during lockdown or as a result of the slow property market,” Qi says.
Consumer confidence is recovering, then, but there’s little domestic appetite for investment in either equities or real estate.
Dividend-paying winners within the Chinese economy
What’s dampening sentiment, says Qi, is not that companies are not growing – they are – but that growth rates have failed to meet the very upbeat market expectations set out when the economy reopened at the start of 2023. Some manufacturers are now under pressure to downgrade their forecasts.
What does this backdrop mean for JCGI, with its focus firmly on hunting out the high-quality, growth-oriented but dividend-paying long-term winners within the Chinese economy?
Qi comments that many of these forward-looking companies continue to try to add value, producing more sophisticated products with higher technical barriers to entry; the current challenging environment has merely dialed up that drive.
Moreover, they remain extremely competitive globally, says Qi; in the face of increasing trade restrictions, “many are seriously considering building or using existing capacity outside China”.
As far as shareholders are concerned, there are also positive developments evident as growth slows down. “Some big businesses, for instance, have become much humbler in terms of capital allocation, making use of share buybacks, getting rid of loss-making companies and even distributing profits from investment portfolio companies,” Qi explains.
She points, for example, to leading Chinese drinks manufacturer Kweichow Moutai, which pays out 53% of earnings as dividends to shareholders – a higher payout ratio than its western counterpart and portfolio stalwart Diageo.
Given that dividends are a useful proxy for the state of corporate governance, this trend is also a welcome indication that standards of governance within China’s larger corporations are maturing.
How is JCGI’s portfolio shaping up? Despite the challenges of the backdrop, it remains focused firmly on the long-term themes embedded in China’s new economy, including healthcare, industrials and information technology.
It also continues to be heavily overweight the China Asia market, rather than Hong Kong. As Qi observes, “Hong Kong has internet businesses, banks and state-owned enterprises (SOEs), but China Asia is where we find most of the private companies with truly entrepreneurial spirit.”
Chinese market leaders are more robust than their share prices suggest
Internet companies still feature among JCGI’s top 10 holdings, mainly because although headline growth has slowed markedly, valuations are now so attractive and capital allocation to shareholders has been steadily improving.
Moreover, even among these companies substantial growth is evident: Qi highlights online retailers Meituan and Pindoudou, which continue to see year-on-year structural growth of more than 20%, while the likes of IT business Netease are expanding in the US and Asia.
“The bottom line is that these and other market leaders are much more robust than their share prices suggest,” she stresses.
Nonetheless, it’s been a tough couple of years for the trust as the market has rotated away from quality growth in favour of value strategies. In the Chinese market, that rotation has benefited large SOEs (which are perceived as low risk) and energy companies, neither of which JCGI holds.
Meanwhile the portfolio was damaged as China’s US-listed internet names and Hong Kong-listed growth and technology companies sold off dramatically. For some holdings the sell-off was justified, but others (such as Meituan, whose share price lost 35% despite strong underlying growth) were effectively victims of the wider market rout.
As a consequence, however, JCGI’s share price was down 16% over the year to end September, compared with the MSCI China benchmark fall of 8.6%.
Yet even against this difficult backdrop there have been unadulterated good news stories bolstering the trust. As well as Netease and Pindoudou, Qi picks out Ningbo Tuopu, which supplies auto components for Tesla’s global business, among others.
“Ningbo is increasing the range of components it makes for Tesla, and also now providing robot parts because Tesla is so pleased with the quality,” she says. “It’s a great example of a highly competitive company that’s helping its clients do great things.”
Significantly, the team was alerted to the attractions of Ningbo by colleagues at JPMorgan Asset Management China. This recent acquisition to JPM’s Asian line-up specialises in small and medium cap businesses, especially cutting-edge industries such as solar and electric vehicles; it should provide a real competitive edge for the Asian office going forward.
What lies ahead?
Of course, the big question now is what lies ahead for China. Valuations are now so low that they have priced in the current negatives and more, says Qi. “My view is that the asset class is very attractive, but recovery is very hard to time.”
She suggests that central measures to support the housing sector and ease funding pressure on local governments will be a key catalyst – and these are already starting to happen. For instance, the Chinese government has just increased the budget deficit level from 3%, where it has been for a long period, to 3.8%, indicating its keenness to rekindle economic growth.
Meanwhile, though, patient investors can take advantage of exceptionally cheap markets to position themselves for eventual recovery. It’s a waiting game.
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The securities above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell. The portfolio is actively managed. Holdings, sector weights, allocations and leverage, as applicable, are subject to change at the discretion of the investment manager without notice. Past performance is not a reliable indicator of current and future results.
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