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

Asia markets were down 2.77% in March, significantly underperforming US markets and also underperforming European markets as the Asia market whipsawed intra month through a high magnitude sell off in China Internet followed by a sharp, large rebound driven by short covering and positive China policy support. Growth stocks underperformed over the month by 1.6% and small cap stocks outperformed almost 4% as China large cap internet led the sell off.

Key performance & positioning updates

The portfolio underperformed the benchmark (MSCI Asia ex Japan) over the month by 271bp. Country allocation was 40bp negative despite our overweight in outperforming ASEAN markets due to the 10% overweight in China A share which underperformed 8% as the worst market. Sector attribution was 30bp negative, due to the continued underweight position in best performing sector of Energy for second month in a row as other value sectors of Financials, Materials, Utilities and Real Estate led the market at the expense of Consumer and Internet.

Market Update

Asia markets were down 2.77% in March, significantly underperforming US markets and also underperforming European markets as the Asia market whipsawed intra month through a high magnitude sell off in China Internet followed by a sharp, large rebound driven by short covering and positive China policy support. Growth stocks underperformed over the month by 1.6% and small cap stocks outperformed almost 4% as China large cap internet led the sell off.

The China/Hong Kong market sold off aggressively from the start of the month to mid March driven by numerous market issues. The US SEC announced the first five US listed Chinese companies that would be up for delisting (in 2/3 yrs) due to lack of audit compliance. There were concerns on US/EU action if China was seen to circumvent Russia sanctions or provide them military aid. Covid cases in China also started to rise, particularly in industrial/IT heavy Shenzhen that went into partial lockdown promoting fears of the economic impact on a already weakened market. Outside these new concerns, underlying issues remained with regard to continually weak property data and internet regulation.

The China authorities promptly stepped in with a coordinated and targeted response to essentially all of these market concerns in one fell swoop that generated a 16% rally in the Hang Seng over just two days driven by internet and property stocks.

They announced their support for overseas listing and as of early April, there is now an understanding that China will allow for full audit disclosures to ensure continued US listing. Whilst blowback from Russia sanctions remains a risk, there was generally positive comments from the Foreign minister urging the need to avoid such implications and as of now there has been little evidence to the contrary besides buying discounted Russia energy similar to India.

The China government also then hinted towards a more ‘Dynamic Zero’ covid policy emphasizing the need to reduce economic impact. This was backed up by Shenzhen production only being down for a few days and overall lockdown being lifted about a week later. Since then however, a more severe outbreak in Shanghai has led to a full lockdown and grounds investor expectation in the regard that eliminating the virus is still the focus despite the economic cost.

Perhaps most notably, there was communication from various government departments that the China Internet regulatory phrase was coming to an end which has acted as a significant overhang for such stocks since Q3 last year. Finally and also importantly, the People’s Bank of China (PBOC) emphasized the willingness to support the stock market with all means necessary, likely through monetary and fiscal means and perhaps direct buying through state related investment funds.

Such market recovery was further aided by substantial short covering in the Internet names such as Alibaba.

Fund Performance & Positioning

The portfolio underperformed the benchmark (MSCI Asia ex Japan) over the month by 271bp. Country allocation was 40bp negative despite our overweight in outperforming ASEAN markets due to the 10% overweight in China A share which underperformed 8% as the worst market. Sector attribution was 30bp negative, due to the continued underweight position in best performing sector of Energy for second month in a row as other value sectors of Financials, Materials, Utilities and Real Estate led the market at the expense of Consumer and Internet.

Whilst value stocks outperforming hindered the portfolio during March, there were two main elements beyond style that contributed to a poor month in relative terms.

We have talked about our underweight in China Internet for a few months now, predicated on weak fundamental trends and regulatory uncertainty. In fact in the 2nd week of March as Internet stocks fell, the portfolio made up about 1.5% relative to the benchmark as a result. Yet when the sector recovered strongly (on positive ADR and regulation news flow), the portfolio gave far more relative performance back than it gained. The key reason is related to our two worst contributors – Alibaba and JD.com, with us underweight the former and overweight the latter combining to detract about 75bp relative loss. Alibaba outperformed JD.com over 20% during March despite both operating in the same Ecommerce space.

There is little to justify such disparity from fundamentals alone, with JD.com in recent results continuing to take share from BABA, outgrowing them in 3P marketplace revenue, whilst also showing significantly better margin trends vs. Alibaba’s continued contraction. EPS revisions back up this trend with Alibaba earnings declining further. JD.com was a consensus long however vs. BABA a heavily shorted stock by hedge funds alike. We believe significant short covering led to such performance dispersion in the rally up and expect the gap to converge over coming months.

The second key detractor of performance relates to our overweight to China A shares vs. our underweight to the Hong Kong market. The latter outperformed the former about 10% during the month, in part because investors cannot short the mainland indices thus no such short covering occurred in A shares. Our A share position cost us about 80bp in asset allocation. Once again, our reason for such positioning is driven by what we consider far superior fundamental trends both short and long term in the A share market. EPS revisions remain robust across A share areas of new energy and IT vs. on going negative EPS revisions in HK market exposed areas of Internet, Property and Hong Kong related stocks (due to covid outbreak).

Whilst the portfolio does not own oil producers (or mining) that do not fit with our investment and ESG criteria, we do acknowledge higher energy prices are likely to sustain for a while, and thus have adjusted our weightings in stocks that have higher correlation to such factors, such as SG and Indo banks (due to commodity trading exposure) and speciality chemical (product pricing driven by oil price).

There has been much skepticism about the recent rally both globally and in China. Inverted yield curves and constant talk about stagflation appears at odd with recent market moves. We prefer to focus on building up a top down view using a wide array of bottom up insights, from earning results, revisions and management commentaries. With this in mind, we have become more cautious in the past month.

In China, there appears to be an underappreciation of the covid situation, with rising cases and a seemingly shift back to more draconian measures of containment at an economic cost. Most industrial companies are reporting supply chain issues and almost all retail companies we have looked at are reporting significant drop off in sales in the 2nd half of March as a result. We do not believe recent price action has completely reflected such weakness.

Property stocks are rallying off continued expectations (and announced) of further housing support, notably through mortgage lending relaxations. Yet sales declines continue to be worse y-o-y in March than prior months.

Before we were becoming positive on the China market due to policy support. In fact macro data from the first two months was generally positive with clear improvement in investment spending and retail sales. However the covid outbreak has slowed such recovery down with little visibility for now. Combined with a market rally before any real signs of fundamentals bottoming out (let alone improvement) across key sectors of Internet, property and consumer, risk reward is far less appealing than two months ago.

We have spoken about China Internet and whilst less regulation going forward is certainly a positive, the sector remains fundamentally weak on market maturity (i.e., lower future growth) and more limiting monetization due to past regulation. Tencent’s results were further proof with topline growth the weakest since IPO bar Q119. There is an ex growth mentality focus by Tencent and Alibaba now, with a goal of higher quality customers and retrenchment into core businesses, confirmed by recent announcements of buybacks, a firm signal high growth and investment days have past.

Whilst you can rightfully argue they are priced for such new paradigm, the fact remains there are little earning trend catalysts for now to encourage us to go overweight the sector as a whole and remain selective. When compared with the trends seen in Mainland stocks, we remain very comfortable with our preference vs. Hong Kong listings.

China manufacturing had been one bright spark over the past 6 months, supported by strong exports as the US and Europe reopened. This recovery has largely been completed, and export growth has started to slow, as shown by PMI contracting for the first time in a while though also impacted by covid. We do not expect a noticeable drop in manufacturing but certainty there is little upside given prior resilience.

We are also seeing potential early signs of demand destruction due to high input costs/inflation across the whole of Asia as is the case globally. In China ecommerce data is suggesting a downtrading trend away from premium to mass market priced goods. In the Philippines the 40% rise in fuel costs have stopped many from driving their car and preferring to work from home, shown in weakening traffic stats and foot traffic in urban retail stores. In India there are signs property developers have stopped building projects due to the excessive construction costs notably steel rebars and PVC piping. This puts a risk to our positive stance on Indian real estate market.

If this trend continues, sector positioning will likely be as per recent months, with Energy and Materials being supported by inflation and defensive sectors such as Utilities, Telco and Healthcare holding up better. Consumer Staples whilst defensive in demand, will be more exposed to inflationary input pressures i.e., soft commodities and oil linked packaging and plastics.

For us to become more positive once again, we will need to see commodity pressures easing, China covid outbreaks to be clearly contained and clearer signs of bottoming up in trends in China (likely linked to containment). We do believe however, that with the clear market and policy support in China, downside is likely limited at the same time and we will see a fundamental recovery at some point this year. As always, timing will be key.