China A-shares: A Remarkably Resilient Growth Story
In this video, Jack Lee, Portfolio Manager of Schroder ISF* China A, share insights into the resilience of China A-shares market and reasons for Schroder ISF China A's peer outperformance.
*Schroder International Selection Fund is referred to as Schroder ISF throughout this page.
Why did China A-share outperform its peers, year-to-date?
Year-to-date, the China A-share market has been more resilient and outperforming its peers in the region.
Despite being the first country with Covid-19 cases, China has been able to contain the outbreak in a relatively short period of time, which, in our view, was helped by the swift and effective responses by the government, including the aggressive use of quarantines.
In fact, except for certain industries such as tourism, that are still affected by the virus outbreak, lives in many parts of China have already returned to normal in mid-to-late February, with many corporates resuming work. In March, basically most manufacturing plants are back online.
We believe the early and successful containment of the outbreak by China is one of the reasons why the onshore A-share market can outperform its peers. We also believe that many investors have been impressed by China’s top-down system and its effectiveness. The successful demonstration of China’s effective crisis management has added further to investors’ confidence in the China A-share market.
What are the key positive factors driving the A-share market?
For sure, the virus outbreak will affect the economy and drag economic growth. In fact, China has just reported its first ever negative quarterly GDP growth earlier this month and the outlook for Q2 remains extremely challenging as most developed economies will likely go through a dramatic sequential growth contraction in the second quarter, which will affect China’s export segment.
Having said that, we can expect greater strength in both fiscal and monetary policies as the Chinese government is looking to mitigate some of the negative economic impact of Covid-19.
On the monetary front, key measures includes the lowering of interest rate and required reserve ratio. The central bank of China has also cut the targeted required reserve ratio several times, hoping to direct more lending towards SMEs.
On the fiscal side, the government has also pledged to do more. The politburo meeting held in late March sent a strong pro-growth signal mentioning the need of raising fiscal deficits, issuing special treasury bonds, and further increasing the issuance of local government bonds to drive fixed asst investment.
These measures are all very supportive to the sentiment of the A-share market.
For Schroder ISF China A, what has been behind the fund’s strong performance?
With regards to the strong performance of our fund year-to-date, we believe sticking to the bottom up stock selection investment process is the key success factor.
On stock level, we have invested into companies that are not too hardly hit by the virus, some have even benefitted from the situation. For example, select healthcare stocks that are specialized in producing medical devices and medical consumables have rallied significantly amid the virus outbreak, as demand for their products surged.
Also, earlier this year, the market was very optimistic about 5G development in China, therefore some of our holdings in the 5G industries have traded higher and generated positive returns.
Elsewhere, some of our holdings in the consumption sector also contributed, as demand for many consumer goods, such as snacks, was very strong during Chinese New Year and also during the lockdown period. We also note that demand for online entertainment increased drastically during the virus outbreak as people stayed home more and longer. These trends are favorable to some of our holdings in the consumption sector.
Where do we see opportunities in the China A-share market?
Looking ahead, we believe the key investment theme could be something related to Fixed Asset Investment in the country given the supportive government policies. Apart from the traditional Fixed Asset Investment such as the construction of railway and expressway, the government has recently promoted the concept of “new infrastructure”, which include 5G, Internet of Things, Artificial Intelligence etc. Therefore, we believe 5G-related industries should be an area of focus going forward.
On the consumption side, we continue to see the rise of more domestic brands and industry leaders in different industries. Many of them continue to exhibit very strong growth potential, which will also be an area of our investment as well.
Last but not least, we believe the government will further increase its spending in the healthcare sector after this healthcare crisis, and we will continue to look for opportunities in this sector.
What are some risks we see in the China A-share market?
Regarding risks for the market, we are aware that there is increasing political noise between the US and China right now. Whether this could escalate further is definitely a real risk to consider. More voices from US politicians request holding China accountable for costs associated with Covid-19 impact pandemic globally, and whether this could materialize into something detrimental is yet to be seen.
Other than that, the tension around technology continues between the 2 major nations where Huawei was rumoured to be subject to further technology sanction. That could also bring more uncertainty towards the companies related to the supply chain. As US-China agreed to phase 1 trade truce earlier and whether the trade deal can continue to be honoured remains of interest.
On top of that, overseas demand definitely will be affected by the pandemic situation and that demand weakness may feed into various sectors in particular the tech space needs to be watched in particular things related to handsets. 2020 is the year of proliferation of 5G and whether Apple’s original scheduled launch of its 5G phone by year end could be delayed is also something of concern.
Various supply chains are disrupted in different parts of the world and that had led to some recent delay in production of Tesla Shanghai plant. Whether the supply disruption of certain critical components could impact certain industry is also another risks we need to think about.
To conclude, we are still optimistic about the China A-shares market due to the strong recovery potential in the second half of 2020.
Schroder International Selection Fund China A: Risk Considerations
Liquidity risk: In difficult market conditions, the fund may not be able to sell a security for full value or at all. This could affect performance and could cause the fund to defer or suspend redemptions of its shares.
Operational risk: Operational processes, including those related to the safekeeping of assets, may fail. This may result in losses to the fund.
Concentration risk: The fund may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the fund, both up or down.
Derivatives risk – Efficient Portfolio Management and Investment Purposes: Derivatives may be used to manage the portfolio efficiently. A derivative may not perform as expected, may create losses greater than the cost of the derivative and may result in losses to the fund. The fund may also materially invest in derivatives including using short selling and leverage techniques with the aim of making a return. When the value of an asset changes, the value of a derivative based on that asset may change to a much greater extent. This may result in greater losses than investing in the underlying asset.
Onshore renminbi currency risk: The fund can be exposed to different currencies. Changes in foreign exchange rates could create losses. Currency control decisions made by the Chinese government could affect the value of the fund's investments and could cause the fund to defer or suspend redemptions of its shares.
Stock Connect risk: The fund may be investing in China "A" shares via the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect which may involve clearing and settlement, regulatory, operational and counterparty risks.
Emerging Markets & Frontier risk: Emerging markets, and especially frontier markets, generally carry greater political, legal, counterparty, operational and liquidity risk than developed markets.
Counterparty risk: The fund may have contractual agreements with counterparties. If a counterparty is unable to fulfil their obligations, the sum that they owe to the fund may be lost in part or in whole.
Higher volatility risk: The price of this fund may be volatile as it may take higher risks in search of higher rewards.
Performance risk: Investment objectives express an intended result but there is no guarantee that such a result will be achieved. Depending on market conditions and the macro economic environment, investment objectives may become more difficult to achieve.
IBOR: The transition of the financial markets away from the use of interbank offered rates (IBORs) to alternative reference rates may impact the valuation of certain holdings and disrupt liquidity in certain instruments. This may impact the investment performance of the fund.
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