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

With frequent mass testing and gradual resumption of production and logistics, China market saw signs of recovery in May. MSCI China All Shares Index is up by 1.8% in the month. Entering June, we observe multiple clear signs of policy shifts – now the policy pendulum has swung to the accommodating side, for the first time since 2Q21. We will discuss details on the policy shifts in the next section.

• A share small caps and growth names that saw capitulation in April are the key outperformers in May. With better-than-feared results, ADRs also outperformed, driven by short covering. From 4Q21 to Apr, names with poor fundamentals and strong policy turnaround expectations (e.g. property developers) significantly outperformed in A share market, while names with good fundamentals (e.g. some growth names) significantly underperformed. In May-Jun, we observe reversal of the “turnaround” bets and strong rotation back to names with good long-term prospects and near-term trends. We believe the rotation is also a result of the China market getting risk-on again with shifts in policies.

• We see a clear path of fundamental recovery from the April trough. Based on our channel check, manufacturing and supply chain have mostly resumed. Reported May total social financing is upbeat on high expectation, and May economic data (industrial production, FAI, retail sales, unemployment) are all better than feared. Domestic liquidity and policies remain highly accommodating.

A Clear Turnaround in Policies

We observe multiple clear signs of policy shift since the second half of May, which may suggest the government is getting nervous about the extremely poor economic conditions under Shanghai lockdown and the potential massive layoffs and unemployment. The clear shift in policies provides a strong basis for China market to outperform global markets in May -June.

o Covid policy – Sudden reopening of Shanghai: Shanghai announced reopening from Jun 1, pretty suddenly. Factories and supply chains are mostly back to normal, though service consumption is still partially constrained. Both Beijing and Shanghai are still reporting new cases, but the management and PCR testing requirements are relatively relaxed according to our local contacts. Another lockdown is highly unlikely. Though China is still aiming for Covid Zero, we see a better balance of controlling the spread of Covid and the economic impact.

o Property policy – Mortgage rate cut exceeded expectations: On May 20th, PBOC announced cutting the mortgage rate benchmark 5-year LPR by 15bps, a stronger than expected sign of policy support for property. Together with cut in discount allowance, mortgage rates can be lowered by as much as 1ppts. New mortgage approval just needs a few days now, among the fastest in history. Besides, multiple high tier cities have relaxed policies for second hand home sales and requirements of new home purchases. Supporting polices for property saw a clear level-up since May.

o Internet policy – New user registrations and new IPOs: YMM and BZ went public in US at similar time to DIDI and got into security investigation together with DIDI. The two companies are recently allowed to have new user registration in early Jun, again, pretty suddenly. Besides, Kuaigou, a company in similar business to DIDI, filed prospectus on Hong Kong Stock Exchange for IPO. This may suggest the policy headwinds on internet companies have ended, and may even turn into policy tailwinds.

o Consumption stimulus – A surprising Rmb60bn purchase tax stimulus for ICE auto: In late May, the government announced a surprising Rmb60nn purchase tax stimulus for ICE auto, which is the sector most severely disrupted by the Shanghai lockdown. While the purchase tax of EVs are already waived, there are further wide subsidy supports from local governments for EV as well. This is the first time we see a large-scale consumption related stimulus in this cycle.

Key Drivers of Performance and Key Portfolio Changes

The Fund returned +1.0% in May, underperforming the benchmark by 80ppts. The underperformance mainly comes from the short covering surge of ICE auto names after the surprising Rmb60bn purchase tax stimulus, and the technical selling pressure on JD by tiger club. We consider the stimulus on ICE a one-off stimulus for half a year, and did not participate. We held on to our EV exposure for long-term structural opportunities, continue supportive policies and high oil price.

• Top alpha contributors of May 2022 are:

o BYD (+22%): BYD has an overwhelming product pipeline with strong orders for hybrids and pure EVs. Particularly, its DMi hybrid technology leads the industry by far and has a sweeping success in sales volume by addressing both mileage concerns and high oil price for consumers. Besides, its integrated business model with self-supply of semis and batteries make their execution and delivery outstanding. It has also officially announced supplying battery to Tesla in June, making it a clear share gainer in the global supply chain.

o PDD (+17%): PDD is offering strong earnings growth and highly attractive valuation. While the market is concerned about its topline growth given its number of users is reaching the ceiling, we think it has big room to cut expenses to deliver margin and earnings opportunities. We also see clear signs that even though the company is cutting marketing expenses, its user frequency is still increasing thanks to its value-for-money proposition – it is on track to become a cash cow, still with at least double-digit topline growth and big room for further expense cutting.

o Pacific Basin (+12%): A high-quality deep-value dry bulk play riding on China stimulus and a strong commodity cycle, particularly for agricultural products. We are constructive on dry bulk cycle and the stock is offering dividend yield of ~15%. However, we have been taking profits in this position as we see commodities rally closing to peak.

• Key distractor of May 2022 is:

o JD (-13%): The underperformance of JD is mainly due to the fact that it is well owned by tiger club funds, and they are selling down positions during the period. To a lesser extent, its 2Q22 guidance slightly missed market expectation. We take the correction and raised JD in the period as we like its longer-term user growth and margin expansion potential, and we consider its valuation is getting attractive.

• Key changes made to the fund:

o When we see the clear policy shifts, we made risk-on and pro-growth adjustments to the portfolio. We cut China financials/property related exposure and raise China internet exposure. We are now OW in China internet.

o For stock picking, we shift our new energy exposure from CATL to BYD and Shenzhen Dynanonics for relatively better risk reward. BYD is seeing overwhelmingly strong sales volume and Shenzhen Dynanonic is globally leading in the next generation LFP cathode technology, recognized by Tesla, BYD, CATL, etc.

As mentioned in our past letters, history tells us that Chinese policies work like a pendulum – it swings from side to side, and just-right is rare. There are various policy mistakes in the past decades (to be fair, there are also a lot of great policies), big or small, but there is always an error correction mechanism to get the country back to right track and grow to its current significance.

• The reason why we are positive on China for the long-term lies in the vast amount of Chinese people who really wants to become somebody in the society and willing to strive hard for it. When they are given the opportunity and when the policy environment is favorable, history tells us they can create miracles.

• History also tells us as long as the error correction mechanism is working, which we see clear signs now, investment return in a 6-to-12-month horizon is good coming from such extreme situations.

• At the beginning of this year, we like China as it is at a different point of economic cycle and policy cycle versus the rest of the world – China is in recession and easing. However, we regret that this call was wrong in the first few months due to the black swan events of Russia-Ukraine crisis and Shanghai lockdown. We still consider this cycle thesis valid, and think there is good opportunity for this thesis to play out.

• As always, please do not hesitate to let us know if you have any questions.