SJB Substanz: New Capital Asia Future Leaders Fund (WKN A2PFKL) Monatsbericht April 2022

Asia markets were down 7.44% in April, underperforming US and European markets as Shanghai was locked down due to Covid outbreaks, prompting further economic growth concerns at a time when there are growing doubts on US growth. Growth stocks ended the month flat vs. the benchmark, in part due to the last day China Internet rally with the HSTECH up 10% on the day from supportive government comments. Small cap stocks were also in line although sold off in the last week on the aforementioned global growth worries.

Key performance & positioning updates

The portfolio underperformed the benchmark (MSCI Asia ex Japan) during April by 86bp. Country allocation was 20bp positive ex cash due to the overweight in Indonesia which was the best performing market. Taiwan and China were the worst performing markets. Sector attribution was negative 60bp ex cash, with limited exposure in Energy, Utilities and Real Estate accounting for -80bp as outperforming sectors. IT was the worst performer as consumer PC and smartphone demand slowed significantly amongst general cyclical concerns.

Market Update

Asia markets were down 7.44% in April, underperforming US and European markets as Shanghai was locked down due to Covid outbreaks, prompting further economic growth concerns at a time when there are growing doubts on US growth. Growth stocks ended the month flat vs. the benchmark, in part due to the last day China Internet rally with the HSTECH up 10% on the day from supportive government comments. Small cap stocks were also in line although sold off in the last week on the aforementioned global growth worries.

Shanghai as of early May is reporting their 10th straight day of covid case decline with their RT rate looking to have peaked even if deaths appear not to have. The government suggest loosening of restrictions can only take place when there are zero cases in the non quarantined areas, which was the case two days ago but then relapsed. Beijing has also started to report about 50 cases thus far but is not yet in full lockdown. Overall Shanghai accounts for the vast majority of cases though an estimated 25% of GDP is currently in full or partial lockdown causing significant economic and logistical damage.

In line with such restrictions, macro data has been atrocious for the past month with net exports the weakest in 2 years, PMI 2nd worst since the Global Financial Crisis and property sales witnessed the worst decline ever recorded.

Similar to mid March, the China government showed clear awareness of market concerns, and came out with announcements early May in response. They emphasized infrastructure spending to support growth, with spend expected to rise to 12% y-o-y, a rate higher than at any point since 2017. Local government special bond issuance for such purpose is already up 500% y-o-y YTD. Further property support was enabled through the ability of developers to use escrow accounts for liquidity. Demand should be helped by continued lower mortgage rates by banks.

Finally, there was a clear implication that the regulation on internet platforms was coming to the end. Whilst this was the same message as was delivered in March (before Internet stocks again underperformed), there was a more positive tone to the message, talking up central government support for the healthy development (vs. control) of the industry.

Outside of China, South Korea and Taiwan were weak on both global growth concerns (as more export led markets vs. India/SEA) and renewed worried on the tech cycle peaking driven by slowing consumer technology such as PC, smartphone and TV in part due to a normalization post Covid stay at home demand benefits.

Fund Performance & Positioning

The portfolio underperformed the benchmark (MSCI Asia ex Japan) over the month by 86bp. Country allocation was 20bp positive ex cash due to the overweight in Indonesia which was the best performing market. Taiwan and China were the worst performing markets. Sector attribution was negative 60bp ex cash, with limited exposure in Energy, Utilities and Real Estate accounting for -80bp as outperforming sectors. IT was the worst performer as consumer PC and smartphone demand slowed significantly amongst general cyclical concerns.

Value sectors (Energy, Utilities, China Property) continue to have a negative impact on the relative performance, however we again stress our commitment to our investment and ESG process that make it difficult to have noticeable exposure to such areas. We attempt to use correlation analysis to identify existing and new stocks that both fit our framework but can also give exposure to such factors. We agree high Energy prices could stay for a while however China property trades entirely on policy speculation for now, with property sales -60% April.

Our worst performer in the month was China Merchant Bank, arguably the highest quality of the bigger China banks. Their CEO abruptly left on rumoured links to a government corruption investigation whilst also reporting weaker asset quality in their larger than peers property portfolio.

Given their CEO was in charge of a relatively successful shift of the bank to a wealth management/retail focus, the stock has been reduced in the portfolio and under review.

We have moved our China Internet stance to near neutral following the more supportive comments from the Politburo meeting. Divergence within remains with regard to fundamental trends as JD.com and PDD continue to take share from Alibaba. We would need improvement in consumer spending along with better margin trends to likely go overweight at sector level. We continue to overweight Financials on improving credit growth and rising rates in India and ASEAN. We have reduced our IT exposure to underweight as we do see signs of weakness in the cycle that has not been reflected in Q2 earnings yet, although structural drivers from Electric Vehicles (EV) and servers remain, clouded by weakness in consumer tech.

We added Samsung Engineering during the month. They generated the highest ROIC (22%) of any engineering company in Asia we can find*, due to their laser like focus on cost control, particularly relevant in cost inflationary environments as now. This is helped by their strategic focus on early project stage design vs. entering late stage for construction like most peers. Management have proven their pricing discipline, being selective in projects but also benefitting from a more rational market with many peers exiting on weak balance sheets over the past decade. They have been growing 30%+ the last two quarters with strong order books from build outs in biologics, semiconductors, EV and also refining & petrol chemical projects in the Middle East.

We think that the low quality (low ROE) value rally that has occurred YTD is losing steam. We believe we see signs globally that growth is slowing and clear negative demand impacts from inflation and logistical costs that has only worsened from the China lockdowns. If this global growth trend does indeed continue to slow, there will be little justification for some of these stocks to outperform and if prior cycles are to go by, you should see a rotation back into quality at first (defensive). A rotation back into growth stocks is less clear, supported by more scarce global growth yet offset by FED tightening, albeit it is the rate hikes relative to expectations that will likely be the driver.

We continued to prefer India and ASEAN vs. North Asia, perhaps more so than prior months due to the China lockdown, slowing global growth (Korea & Taiwan export exposed) and our more cautious view on the IT cycle, also Korea and Taiwan focused. On the flipside, the best earning revisions in light of this are found in ASEAN and India. Indonesia continues to recover out of lockdowns but with the added benefit of being a net exporter of commodities along with Malaysia. India we are small overweight, with broad based recovery also in play, however unlike the ASEAN region, inflation is much more a concern and rate hikes are likely to taper growth momentum in second half 2022. Inflation is higher here due to the more mature recovery but also being the biggest net importer of oil in the region. High crude prices have only been passed through to pump prices just in April so any negative impact is yet to be seen and will be watched closely over the coming months.

The China authorities have clearly demonstrated both at the end of April but also mid March, that they do care bout the stock market and investor concerns, as shown by their targeted responses to key issues, such as ADR delisting, Internet regulation, property weakness and Covid policies. This awareness along with continued monetary and fiscal stimulus, offers notable downside protection to the market further helped by attractive valuations, with at least the A share market at trough levels vs. the past ten years. M2 money supply and credit impulse pre lockdowns was improving along with selective macro data.

We believe that the People’s Bank of China (PBOC) will not go to extreme levels in easing, given US tightening and capital outflow concerns along with inflationary pressures. They will also not be too aggressive in fiscal stimulus given local government debt levels and excess capacity in many areas. That said, fiscal spending is still to between 5-10% 2022 vs. 2% 2021 with infrastructure spend growth a little higher than that. The CSI300 is well positioned vs. the Hang Seng to benefit from such policy support as it also outperformed HK in prior times during 2014/15 and 2019. This is because the market is naturally more exposed to RMB liquidity conditions vs. HK more USD.

The timeline regarding China’s covid situation is difficult to predict but there was a positive suggestion last week that such Zero Covid policy is only temporary until elderly vaccinations (booster) reach acceptable levels. Currently this is 55% of over 60s vs. 80%+ of the population as a whole. There remains a concern on the efficacy of the Sinovac vaccine vs. Omicron but the heavy use of Pfizer’s pill is intended to reduce severity. Given China’s typically rapid response times to such initiatives, we expect the elderly vaccination rate to surpass 80% in the coming weeks and only then may we see some softening of policy approach. Until such policy shift, there will inevitably be further outbreaks even when Shanghai recovers and thus will act a constant market overhang until an approach closer to ‘living with Covid’ is announced. There is no question China will not reach their 5.5% GDP growth target, with consensus currently at 4.8% and falling. With global growth slowing, even if the domestic economy improves (I.e., consumer spending and investment) exports will likely have peaked and no longer supportive as it was. Even though China fundamentals remain weak and likely will for coming months regardless of Covid, we are wary to be too underweight China/HK given the power such policy announcements can have in a very quick time. Our base case is Covid policies will be relaxed and stimulus will start to have a positive impact on macro and fundamental trends nearer the end of Summer months, and with valuations attractive, such 2H market recovery remains on the cards albeit delayed.