Fund Commentary - March 2020
In March, a further slowdown in the percentage rise in new coronavirus cases in China, along with comprehensive yet moderate policy action, helped stabilize investor sentiment within Chinese markets. China’s government hinted toward a ‘more proactive’ fiscal policy opening the door to higher budget deficits and raising of debt quotas including local bond issuance for infrastructure projects. Recovery has begun. Factory workers are reporting back to work, local shops and restaurants are accepting walk-in customers and some travel restrictions are being lifted. Life in China began slowly normalizing. Economic disruption aside, global investors saw clear benefits to having some China exposure within their portfolios. Chinese equities diversified return streams and helped to dampen downside volatility.
PERFORMANCE, CONTRIBUTORS AND DETRACTORS:
For the month ending March 31, 2020, the Fund returned -6.75%, roughly in line with its benchmark, the MSCI China All Shares Index, which returned -6.84%. From a sector perspective, the Fund’s holdings in the consumer discretionary and information technology sectors contributed to relative performance. In contrast, the Fund’s holdings in the financials and consumer staples sectors were detractors to relative performance.
A contributor among individual stocks was Lepu Medical Technology, a pharmaceutical and medical device company. The company expanded their core business from medical stents to include cardiovascular drugs. In 2019, Lepu was also first to market with a new product line of biodegradable stents, designed to dissolve after use. The company projects attractive profit growth and in our view is attractively valued.
A detractor among individual stocks was Galaxy Entertainment Group, a Macau casino holding. Global tourism came to a halt in March amid the coronavirus outbreak. While the travel and tourism sector may take some time to recover, we remain constructive on Galaxy Entertainment and believe growth could resume as travelers resume their trips. The status of gaming licenses for certain operators would also bode well for companies in this sector should their bids to renew licenses be granted.
While recognizing the significant health care and economic impacts of the crisis on China’s citizens and businesses, economic activity is resuming in China. Most workers in China are back to work. In Wuhan, the epicenter of the COVID-19 outbreak, malls and many restaurants are open again. People continue to wear masks and domestic travel within China could resume as early as May. We believe China’s central government now has a playbook on how to act more quickly at a micro level to contain the spread of the virus.
Considering risks to China’s economy, we note that China is not immune to a global slowdown in economic growth. At the same time, there is increased discussion of a possible stimulus from Chinese policymakers. Moreover, the Fund’s holdings tend to have strong cash flows and strong competitive moats. This may enable them to weather a more prolonged recovery phase and at the same time consolidate the market as smaller and less efficiently run businesses fall behind. Economic disruption may help better run companies strengthen their competitive positions.
Looking ahead, earnings are likely to be revised down meaningfully. Prior to the outbreak of the virus, Chinese businesses were forecasting a strong earnings cycle for 2020. As the impact of the virus begins to dissipate, we have reasons to believe that economic growth may remain healthy. There are fundamental reasons why the corporate growth earnings cycle in China can potentially restart as concerns about the coronavirus begin to recede. We expect that China’s economy could show signs of recovery in the second half of 2020.