SJB Surplus: New Capital China Equity Fund (WKN A1J3EX) Monatsbericht Dezember 2022

Key events in market
The China market extended the rebound by 3.9% in December, outperforming global markets, thanks to the sharp reversal of the three major factors dragging the 2022 China market in November to December, namely Zero Covid policy, property and geopolitics. Particularly, due to the fast spread of Covid in Mainland China, the onshore A share market saw quick trading volume contraction of ~50% to a YTD low by mid-month, further extending the historic underperformance versus offshore H shares and ADRs.

Key performance & positioning updates
The Portfolio underperformed the benchmark (MSCI China All Shares Index) during December by ~1.2%. The underperformance is mainly due to the extension of historical performance divergence of Hong Kong/ADRs (up by ~10%) versus A shares (down by single digits) during December, and the structural overweight the portfolio holds in A shares as we find more long-term structural opportunities in the market.

Market Update

Driven by sharp reversal of the three major factors dragging the 2022 China market in November to December, namely Zero Covid policy, property and geopolitics, the China market extended the rebound by 3.9% in December. In our October market commentary, we wrote that the new leadership team from the 20th National Party Congress is not as bad as what the market’s price action suggested. Besides, Covid policies and property policies are binary factors for the China market, whose importance is more pronounced than any single drivers we have seen in recent years. We think the three major developments in November – December prove that the new team do care about economic development, rather than just focusing on politics as some investors feared. Covid policy officially entered full reopening in December. Policies seemed to opt for a quick herd immunity with a target of back-to-normal by end of 1Q23. However, the policy shift was driven by public anger towards Covid Zero, with little preparations made in raising vaccination levels, preparing hospital facilities, building up medicine inventory, etc. This has made the reopening difficult. Taking a longer-term view, however, reopening is a positive. While official data cannot show the status of Covid spread in the Mainland, we can tell the impact from the quick and sharp contraction of trading volume in the onshore A-share market. From the beginning of December to mid-December, the daily trading value of A-share markets quickly contracted by ~50%, from >Rmb1trillion per day to Rmb500-600bn, as a large number of market participants were sick at home. This led to the dull performance of A-share markets during December, despite developments in fundamentals. With low trading volume, single stock volatility and price movements are getting increasingly high and abnormal. Meanwhile, with the Covid policy shift and little impact on market participants, Hong Kong market performance led global markets. We expect relative performance convergence of A-shares and Hong Kong/ADRs when the key financial hubs in Mainland China reach herd immunity and onshore trading value rebounds.

CWEC that set the policy tone for China in 2023 was held in mid-December. Our key takes: 1) Expectation for the global macro environment is negative, so policies are progrowth. Domestic demand and consumption are the key focus amid falling overseas demand and exports. In 2022, the key focus is common prosperity; 2) However, policies need to have a balance between near-term challenges and long-term goals. Overall tone implies 5% GDP growth target, but lower than this level due to Covid and a fall in export demand can be tolerated. Policies are likely to be data dependent, with high flexibility, which means no outsized stimulus in the near-term; 3) Tone towards internet companies is more friendly, asking them to “lead development, create jobs and compete at the international stage”, versus “preventing irrational expansion of capital” in 2021, and “developing traffic lights for capital” in 2022. This means any further negatives from the policy side on internet companies may take a breath in 2023; 4) Property maintains the long-term target that housing is for living and not for speculation, but it is also recognized that a stable property market is crucial for a stable economy. We have seen various supply side policies since November, but new home sales dipped again. It remains to be seen what kind of demand side policies for high-tier cities can be introduced and whether it works; 5) Fiscal and monetary policies are supportive, but the level of stimulus is below market expectation. Particularly, “bringing forward infrastructure investments” is deleted for the fiscal policy and being aware of inflation is mentioned for monetary policy. Overall, with the low base in 2022, it does not require much stimulus for the Chinese economy to achieve 4.5-5% growth in 2023, with recovery in consumption (less Covid restrictions) and property investments (fewer incomplete projects and land sales are not counted in GDP). Policy direction is pro-growth, but the level is a miss versus some high expectations by some investors running into the meeting.

Fund Performance & Positioning

The Portfolio underperformed the benchmark (MSCI China All Shares Index) during December by ~1.2%. The underperformance is mainly due to the extension of historical performance divergence of Hong Kong/ADRs (up by ~10%) versus A-shares (down by single digits) during December, and the structural overweight the portfolio holds in Ashares as we find more long-term structural opportunities in the market. Our top alpha contributors of the month were H World Group, Trip.com and China Merchants Bank. H World Group and Trip.com were our top picks for China reopening, and they have been our top alpha contributors for several months. We initiated positioning in China Merchants Bank when its valuation fell to below book due to concerns on asset quality related to property and credit cards. With property policy shift and economic recovery, we expect re-rating in China Merchants Bank. Our key detractors of the month were the A-shares holdings. As discussed previously, the wide spread of Covid in the Mainland has led to sharp contraction in trading value, rising volatility and abnormal price movements in A-share markets. We expect relative performance convergence of A-shares and Hong Kong/ADRs when the key financial hubs in Mainland China reach herd immunity and onshore trading value rebounds.

China reopening is now confirmed, with the timing earlier than the market anticipated. We estimate underlying economic growth can recover from ~2% to ~5%, with normalization of economic activities and recovery of consumer and business sentiment. Key investment opportunities we have identified are: 1) consumption, seeing the largest sequential recovery for the Chinese economy; 2) new energy like solar and offshore wind, which is on track to deliver strong volume growth, though we are relatively conservative on electric vehicles (EV) due to already high penetration and demand uncertainties in both China and the US.