Value Partners Classic Fund commentary for the first quarter ended March 31, 2015.
- Value Partners Classic Fund (the “Fund”) primarily invests in stockmarkets of the Asia-Pacific region, with a Greater China focus.
- Please pay particular attention to the risk of investment in China and other markets in the Asian region and in companies with medium or small capitalization. The value of the Fund can be extremely volatile and could go down substantially within a short period of time. It is possible that the entire value of your investment could be lost.
- The Fund may also invest in derivatives which can involve material risks, e.g. counterparty default risk, insolvency or liquidity risk, and may expose the Fund to significant losses.
- You should not make investment decisions on the basis of this material alone. Please read the explanatory memorandum for details and risk factors.
Chinese stocks made a winning start to the year as share prices rallied towards the end of the first quarter underpinned by easing measures from the People’s Bank of China (PBoC) and strong investor sentiment on the mainland. Value Partners Classic Fund increased by 6.5% in the first three months of the year. For reference, the Hang Seng Index and MSCI China Index were up 6.0% and 8.1%, respectively, over the same period.
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Value Partners Classic Fund – Growth and reforms
At the National People’s Congress (NPC) meeting in March, China announced to lower its economic growth target for 2015 to 7%, a widely anticipated move to achieve soft landing. Job creation is a critical focus with new urban job target kept at 10 million, reflecting the government’s desire to maintain a healthy level of employment to ensure social stability. Meanwhile, with economic data deteriorating early this year, Premier Li Keqiang called for “more forceful” fiscal policy and “appropriate” monetary policy to help stabilize growth. Indeed, the PBoC made a number of announcements to increase liquidity since the second quarter of 2014. In February 2015, reserve requirement ratio for banks was cut across-the-board the first time since May 2012, allowing banks to hold less deposit reserves. Furthermore, a symmetric interest rate cut of 25 basis points followed last November’s asymmetric one to reduce the cost of borrowing. On 30 March, the central bank extended relaxation measures to the property market and lowered the required down payment for second-home buyers to 40% from 60%. Such a step up in stimulus represents a new cycle of monetary policy and reconfirms our expectations for continuous easing measures.
While growth is a primary area of concern, we remain optimistic about the acceleration of China’s structural reforms. At the NPC meeting, Premier Li pledged that there will be breakthroughs in major reforms. We welcome the program of deregulation, market-opening, economic re-balancing, more respect for the rule of law and the drive against bad practices in the government and corporate sectors. In the near term, financial reforms remain the lowest hanging fruit. With the establishment of a deposit insurance scheme, interest rate deregulation will likely happen earlier and improve the efficiency of capital allocation. With lower lending rates, banks may consider lending more to the private sector to maintain margins. Meanwhile, China’s plan to drive public-private partnership to encourage private capital in traditional government investments will likely take longer time to implement. We are hopeful that some of the pilot programs announced in the third quarter of 2014, especially the reduction of capital expenditure that is driving state-owned enterprise (SOE) reform, will see some initial results in 2015. With these reforms driving governance and growth, this will likely reverse the price-to-earnings de-rating trend of Chinese stocks and bring about significant multiple expansion in the coming years.
Value Partners Classic Fund – China’s A-share momentum spilling over to Hong Kong
We recognize that many investors remain wary about the China story, particularly as the country’s development model matures, resulting in a slower growth rate. No doubt, it is going to be a volatile market. But at this point of the cycle, a combination of monetary loosening and reform measures has driven capital into the A-share equity market. The domestic A-share market remains red hot. After gaining 55.8% in 2014, the Shanghai Shenzhen CSI 300 Index continued its rally in the first quarter and went up by a further 14.7% with much of the returns coming in the month of March. The euphoria has undoubtedly been boosted by greater retail participation as new brokerage accounts were opened at a record rate of 1.67 million per week. It is unsurprising that regulators are worried that a potential bubble is forming and the government may seek to divert capital out of the A-share market. A similar attempt was the margin trading clampdown in January when regulators punished non-compliant brokers to stabilize margin trading activities.
One diversion for the strong capital flows in China’s A-share market is the Hong Kong stockmarket. Hong Kong-listed Chinese companies have been trading at an attractive discount to A shares. For dually listed A/H shares, the discount has hit a recent high of 35% at the end of March 2015, according to the Hang Seng China AH Premium Index. Coincidentally, at the end of March, the China Securities Regulatory Commission (CSRC) announced that domestic fund management companies can buy Hong Kong-listed shares via the Shanghai-Hong Kong Stock Connect program without a Qualified Domestic Institutional Investor (QDII) license requirement. Immediately, we saw a revival in the southbound leg of the connect program. The euphoric market environment in the A-share market will likely continue to spill over to the Hong Kong market.
Value Partners Classic Fund – Portfolio review and outlook
From a portfolio strategy perspective, we maintain a very positive stance on equity markets. We have maintained an aggressive positioning for over a year now and this has been beneficial to the portfolio’s return during this period. At the end of March, there was a temporary increase in cash level due to strong subscriptions as well as position rotations to more attractively valued stocks, therefore we have promptly moved the portfolio to fully participate in the market rally. From an asset allocation perspective, majority of our investments remain in Hong Kong-listed Chinese companies, including a large exposure to insurance and property sectors that benefit from the loosening monetary environment. Meanwhile, we continue to have an elevated exposure in the A-share market although we have rotated some positions from Shanghai A shares into Shenzhen A shares.
We believe that China’s insurance industry is in an upcycle. The life premium business has seen a recovery in 2014 and growth in new business value (NBV) has accelerated. One of the key drivers is less attractive investment alternatives; interest rate cuts have selectively reduced deposit rates and with a slowdown in wealth management products, insurance products stand to benefit. We expect this trend of investors shifting their asset allocation from yield-chasing shadow banking products to insurance products to continue. The current pace of growth is further supported by increasing agent numbers and turnaround of the bancassurance business (selling insurance products via banks). Furthermore, with the strong A-share market, Chinese insurance companies’ investments have been profitable. In the next 12 months, we anticipate that tax incentive support for investments into pension products and health insurance will likely serve as a catalyst for further growth in premium income. As of the end of March, Chinese insurers are trading at an average price-to-embedded-value ratio (P/EV) of 1.24x, which is at a discount to the 5-year historical average of 1.43x. Moreover, the strong stockmarket performance also leads to a boost in insurers’ book and embedded value, bringing about increasing forecast estimates in the embedded value and even more attractive P/EV valuations.
Going forward, we expect the further opening up of China’s capital market via the proposed Shenzhen-Hong Kong Stock Connect, as well as the potential A-share inclusion in international indices, will act as a long-term catalyst for market re-rating. While it is only three months into the year, we are looking forward to a stronger market environment, which is particularly beneficial to value investing as investors are less focused on a few smaller fast-growing sectors but more focused on the merits of each company on a fundamental basis. Despite the strong rally, we think that the long-overdue recovery in China-related stockmarkets has only just begun, and we continue to find value in the Chinese equity markets.
Value Partners Investment Team
16 April 2015
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