Dear Esteemed Clients,
You might recall that I had written in our Elixir Private Wealth newsletter (for clients only) about an Ultra High Net-worth Family Office Conference I was invited to in Macau about 2 years ago. We were the only Australian Financial Planning Firm to be invited (I suspect on the back of our nomination as “Professional Planner magazine and Business Health’s ‘Best Practice Award’ for 2013”). I met with one of the largest Fund Managers in China (a Chinese company) and have maintained that contact. Today, I have received an insight from them on the Chinese markets and the view of most institutional managers there, which I will now share with you.
Most of the Fund Manager Institutions in China invest largely through Hong Kong. The reasons for this are twofold.
Firstly – Hong Kong is a far better regulated market than Shanghai, with a level of governance (listing requirements, continuous disclosure etc.) that is on par, if not superior to, western exchanges.
Secondly – Hong Kong is a market dominated by institutional investors (again, similar to western exchanges). Shanghai is dominated (80-90%) by retail investors. As a consequence, Shanghai is a far more volatile exchange. It is these retail investors (increasingly using margin loans and buying small/mid-caps) that saw the Shanghai Exchange rally up to 150% over the last year (by comparison Hong Kong rallied up to 20%).
Over recent weeks, while Hong Kong shares have fallen – they have not fallen to the same extent as Shanghai. Furthermore, Hong Kong H-shares (companies incorporated in mainland China and listed in Hong Kong) are trading on sub-10 forward P/E (Shanghai is on a forward P/E of approximately 14). It is also worth noting, over the last 12 months , many fund managers have been shifting from Shanghai shares to Hong Kong shares as Shanghai rallied disproportionately.
Looking forward, we expect the government to continue to support the country’s equity markets (Large-Cap Shanghai shares in particular) so that they are then able to carry out reforms such as privatizing State Owned Enterprises (SOEs). There are plenty of funds available on China’s balance sheet to provide liquidity into the market. Also, with the correction, this will curb margin lending – which is a medium-long term positive for the market.
Over the medium term, SOE and financial reforms will provide a positive catalyst for the market. In the long term, China’s exchanges are still to be included in many global indices including the MSCI. In which case ETFs, index trackers and benchmarked funds will allocate. This means an abundance of international funds moving into China’s markets, diminishing the role of China’s domestic retail investors who are currently the majority participant.
Below is commentary on the Shanghai Exchange from Premium China Fund’s Investment Director/Portfolio Manager, Alan Wang.
The worst performers in the past weeks are the small caps. We think in the current market environment, in order to minimize volatility, large caps which the majority of our China Fund is invested in or cash are probably better options compared to small caps.
As we have always emphasized, many of the small caps names are thematic and momentum driven. As they lack fundamental support, they got traded off (bubble busted) first amongst this massive selling pressure out there now. Besides, clearly the Chinese government has thrown out a lot of measures in the past week to rescue the market and majority of the asset injection is benefiting the large caps.
For instance on Tuesday, amongst the backdrop of a down market, there are around 90 stocks that are delivering positive returns and majority of them are banks and insurance companies (some even limit up).
We continue to add large caps (but mostly defensive and consumption related names) and remain minimal exposure in small caps. We also maintain the existing exposures on Hong Kong names as we still prefer H-shares over Shanghai A-shares.
We believe this market correction has benefited those who did not blindly invest and speculate base on momentum and news flow and investors will learn to appreciate value investing and to look into the fundamentals of the company. Bottom-up analysis will also add more value to investors’ portfolios as we see a big divergence in performance in the market.
Finally, we still believe that with government’s conviction, the market will eventually stabilize and be back on track for a slow, long-lasting and healthy bull. Yet the recovery of the A-shares market may not be imminent. but with the improvement in liquidity together with more aggressive rescue measures from the government, under the backdrop of a monetary easing environment, we will be able to uncover a lot of good (or even better) values in companies that have strong fundamentals and growth outlook, and overall the long term outlook of China stock market remain positive.
Once again, I reiterate that we have positioned portfolios more conservatively then in the past, as we have had the view that markets would correct at some stage. We have also relayed this thinking to our clients over the past couple of review meetings. Our portfolios have stood up very well against this backdrop of market volatility and correction over the past few months. We will continue to monitor the markets and client portfolios and will make the necessary changes when warranted and appropriate.
Again, please contact me if you wish to discuss further or if you have any queries on your portfolios or wish to discuss coming on board as a client of Elixir Private or Family Wealth.