2019 Best Greater China Equity Fund - Schroder ISF Greater China A1 Acc USD

M: Morningstar S: Schroder

M: Can you highlight any major changes you made to the portfolio over the course of 2018? Were there any particular holding(s) that drove the fund’s performance for the year?

S: Stock selection in China was a key driver of alpha generation. From a sector perspective, stock selection in health care, consumer discretionary and IT sectors added value.

The fund’s top contributor over the period was a biological drug company. Shares rallied after the Chinese government’s announcement to accelerate the approval of new drugs which would help the company move forward more quickly in terms of later development stages of its projects where higher revenue per project would be earned. Another contributor was a gold miner. Shares of the company were buoyed by higher gold prices. Further contributions came from our off-benchmark position in an A-share listed leisure and travel operator, which saw its shares advance on strong momentum in duty-free store sales and a successful consolidation. In Taiwan, our overweight position in a camera lens provider was also a positive contributor during the year after the company reported strong 2Q results.

M: What is your outlook for 2019 specific to the markets you cover, and how are you positioned to take advantage of opportunities and/or mitigate potential risks?

S: Following a cyclical recovery in 2017 driven by robust domestic demand and supply-side reforms, emphasis has since shifted to the quality of economic growth. This focus on quality growth as well as economic and social stability brought about a renewed focus on reducing the shadow banking sector. The government’s efforts to deleverage the economy and increase regulatory oversight led to concerns around economic growth in 2018. Indeed, we saw credit conditions tighten on the back of reduced shadow banking activity. Tighter credit led to a rise in credit defaults, while areas including industrial production and fixed-asset investment also lost momentum.

Against the backdrop of a slowing economy and escalating trade tensions with the US, China has introduced various measures to help support the economy, including the delayed implementation of regulations on wealth management products, RRR (reserve requirement ratio) cuts, the acceleration of issuance of local government bonds, encouraging banks to increase lending to small and medium enterprises, the State Council’s guideline to support domestic consumption, and potential changes to tax regimes. We believe that these policies are aimed at cushioning downside to the economy rather than providing large-scale stimulus. A weak renminbi and high debt levels also limit policymakers’ ability to stimulate aggressively. The government will need to continue to balance its agenda for deleveraging and introducing structural reforms whilst maintaining reasonable economic growth.

On the trade front, our base case remains that a wide-ranging destructive trade war is not in anyone’s interest. The risks to Chinese and Asian earnings remain hard to gauge given the announced tariffs to date are relatively narrow in scope and will have little impact on the listed corporate sector. We see limited scope for Chinese manufacturing to be re-shored to the US, or substitution of US goods in place of Asian imports. However, it is the second-order impact on capital expenditures and investments, and potentially on consumption, that is harder to measure. The renminbi is an unlikely tool should trade tensions continue to escalate given the risk of inciting capital flight, but currency weakness may be seen as a result of US dollar strength.

The risk of a full-scale and protracted trade conflict is longer term, with China’s strategic industrial policy blueprint and a Sino-US technology arms race at the heart of the issue. China has already shown its willingness to negotiate on trade issues to narrow the trade deficit, reduce import barriers and further liberalise its domestic market. However, China is unlikely to move on its strategic vision to transform itself into a technology leader.

M: How have financial market risks, such as the ongoing trade war between the United States and China and tightening monetary policies in major economies, impacted your recent investment decisions? What are some underreported risks that could surface in 2019 or beyond?

S: Looking ahead, mid-teens earnings per share growth that is currently forecast for the Chinese market is likely to moderate in 2019. Valuations for Chinese equities have become more attractive and suggest upside for investors over the medium term. However, we remain cautious in the near term given the likelihood of further cuts in earnings forecasts and continued uncertainty on the trade front.

Across the straits in Taiwan, the domestic economy remains anaemic, with overall credit growth subdued over recent years. Cross-strait relationships have unsurprisingly deteriorated since the Democratic Progressive Party (DPP) claimed election victory in May 2016. The stock market, however, has been well-supported by dividends and select globally competitive technology companies which are trading at attractive valuations.

We remain relatively defensively positioned given the current environment, with most of our exposure concentrated in domestically focused names and sectors showing structural growth trends. We remain underweight in technology stocks given uncertainties brought about by regulatory headwinds and scrutiny. We are also positioned in financials, particularly interest rate sensitive stocks (namely Hong Kong banks with dividend yield support) as well as Chinese insurance companies. In the medium term we continue to favour domestic Chinese and Hong Kong consumption names, where we are seeing a pick-up in offline consumption spend as well as retail spending in Hong Kong. We are selectively adding in sectors such as healthcare where we see value emerging post market corrections in 4Q 2018.

Our holdings in Taiwan are mainly in the area of technology, and these are held across a number of industries including semiconductors, iPhone assembly as well as computer hardware and electronics. We remain focused on companies with strong fundamentals, and with further market weakness, we will be looking for opportunities to re-enter or rotate as value re-emerges.  

M: How is your investment team organized? Have there been any changes to the investment team or structure over the past year? Do you anticipate adding to the team in the near future?

S: The Schroder ISF Greater China is managed using a team approach with Louisa Lo, a regional and Greater China fund manager with 25 years of investment experience, as the lead fund manager.

Louisa is further supported by the wider investment professionals of our Greater China equity team, comprising of 3 other portfolio managers and 19 research analysts with investment experience that averages 14 years. The experience of the team through market cycles, the growth of the market, companies and management, provides Schroders with a unique understanding of the opportunities in the market. The cohesiveness of the team lends itself to a greater understanding of the strengths and biases of individual professionals allowing greater focus on the key factors driving company performance and second, a focus on investment and not on administrative or distracting issues. An experienced team is critical to gain the greatest insight into the opportunities in the market while the cohesiveness of the team ensures efficiency in implementation.

M: Where do you feel that the investment team or the investment process can be improved upon in the future?

S: Schroders has a disciplined approach to managing Asia ex-Japan equity. The robust process has been enhanced over more than 25 years. In our approach, we place primary emphasis on our capability to generate investment insight through bottom-up research with a top-down macroeconomic and risk-controlled overlay. This repeatable approach and discipline in execution provides confidence for our investors with continued strong performance.

Being an integral part of a broader regional Asian team, our Greater China team shares but importantly also leverages off invaluable insights on businesses in other parts of the region to consider deeper implications for China’s industries and businesses. Being part of a global asset manager lends further advantages through an integrated research sharing IT platform that consolidates and stores research perspectives across asset classes globally, allowing us access to first hand insights to emerging trends in other parts of the world.

View all Morningstar Hong Kong Fund Awards 2019 articles here.