Fund Commentary – August 2019
MARKET ENVIRONMENT:
Chinese equities were down in August. Hong Kong protests featured prominently in global headlines, creating negative sentiment among some foreign investors. Trade tensions also simmered and Chinese economic data reflected a moderate slowdown. Stocks suffered as investors remained on the sidelines.
Hong Kong protestors demanded universal suffrage and the repeal of the extradition bill (among other requests) in August. Following the reporting period, Hong Kong leader Carrie Lam announced in early September the withdrawal of the extradition bill. While protests may take additional time to unwind, there seems to be some incremental progress in conversations between the government and the people of Hong Kong. With the extradition bill now withdrawn, both sides have acknowledged that housing costs, income distribution and economic mobility are issues that need to be addressed. Notably, the portfolio has very limited exposure to companies directly impacted by the protests.
Turning to trade issues, U.S. President Donald Trump’s approach to trade negotiations appeared to be largely improvised in August. While some believe a trade deal with China may be required for President Trump to win re-election, the path toward any speedy resolution seemed unclear in August. We continue to believe it is in the best interest of both sides to reach a deal over the long term.
PERFORMANCE, CONTRIBUTORS AND DETRACTORS:
For the month ending August 31, 2019, the Fund returned -3.54%, holding up slightly better than its benchmark, the MSCI China All Shares Index, which was down -3.95%. From a sector perspective, the Fund’s holdings in the health care sector contributed to relative performance. In contrast, the Fund’s holdings in the financials sector detracted from relative performance.
A contributor among individual stocks was Sino Biopharm, a leading pharmaceutical drug manufacturer in China. Despite the government’s push for affordable health care and the overhang of price cuts in generic drugs, Sino Biopharm has been executing well in terms of diversifying and enhancing its product mix to include more innovative oncology drugs, which has shown considerable growth. The company also has increased its spending on R&D in past years, and we believe that it has built a sufficiently strong pipeline to capitalize on the growth of innovative drugs in China in the years ahead.
A detractor among individual stocks was Ctrip.com International, a travel booking site. Weakened sentiment on outbound travel from mainland China to Hong Kong and Taiwan on account of the Hong Kong protests and government restrictions on individual travel to Taiwan dampened sentiment on the company’s near-term growth prospects. General macroeconomic worries among investors also weighed the company’s stock price in August. However, we continue to like the long-term prospects of the company. Increased demand for travel services is a long-term, secular trend in China and Ctrip continues to diversify its revenue sources in catering to both increasing domestic as well as global travel among Chinese consumers.
OUTLOOK:
U.S.–China trade tensions remain unresolved, but equity prices already reflect a high degree of uncertainty. We believe a broad range of macro risks are already priced into Chinese equity markets. Following the reporting period, the U.S. and China announced plans to resume trade talks in October, which could be a positive step. In the near term, market participants would welcome an improvement in the tone of dialogue.
In a bright spot for markets, earnings among Chinese companies remain fairly resilient. We see particularly strong earnings from the health care, technology and consumer staples sectors. On the back of strong earnings, some domestic Chinese stocks, known as A-shares, have generated outsize stock returns year to date, so we continue to monitor valuations of our holdings onshore.
In contrast, offshore Chinese stocks, known as H-shares, have been somewhat flat year to date on weak foreign sentiment stemming from trade tensions and protests in Hong Kong. The all-shares approach of the portfolio allows us to evaluate valuations and investment opportunities in both onshore and offshore markets, so we continue to allocate capital based on where we find the most compelling opportunities from the bottom up.
Lackluster economic data could prompt China’s policymakers to roll out modest, incremental stimulus. We do not expect broad-brush stimulus ahead, but we believe the likelihood of a modest uptick in stimulus is increasing. We remain positive in our outlook for China over the long term and believe that exposure to China’s dynamic marketplace is essential for investors looking to capture a larger share of global growth.