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January 2021

Key takeaways:

It has been a very complicated start of the year. In terms of absolute performance, our funds gained in value but on a relative basis compared to their respective benchmarks, they underperformed significantly. Despite a resurgence of global volatility, China in the end did well in January, and so did Korea, Taiwan and Singapore. At the other end of the spectrum the Philippines did very poorly (down 7.4%), while India, Malaysia and Indonesia also lost ground. China outperformed once again all other major markets in the world. However, a granular analysis of the different markets of China shows that stocks, and even markets themselves were literally “all over the place”, with some major rotation from the A share markets of Shanghai and Shenzhen into the H share market of Hong Kong and Hang Seng Index constituents. The Shanghai Composite index gained 0.3%, the Shenzhen Composite index 0.2% when at the same time the Hang Seng index gained 3.9%, the Hang Seng Chine Enterprise Index 4.4% and the MSCI China 7.4%.

Fund raising in mainland China had never been as high as it has been in January. No less than RMB120bn (or USD18.5bn) were raised by retail funds in the first five days of the year, many funds attracting more than RMB10bn in one day. Given the high valuation of the 100 A share companies that typically attract two thirds of mainland investors’ money, mainland fund managers decided in herd to position themselves on the Hong Kong market where they are allowed to invest up to 50% of their assets. This move was also in reaction of the sharp falls a few Chinese giants listed in Hong Kong had to suffer when American fund houses and Exchange Traded Funds were forced by the US administration to sell their positions in 33 companies including China Mobile, China Telecom and China Unicom for being allegedly related to the Chinese army. At a time when the RMB is on an appreciating trend against the US dollar (and thus against the HK dollar), and with a A/H average premium at the start of the month of 40%, Hong Kong became all of a sudden a very attractive investment proposition for mainland investors. Southbound Stock Connect flows into Hong Kong over the first three weeks of January added up to one third of the entire activity of 2020.

Key beneficiaries of this rotation were 1) the mega-caps that are not accessible by mainland investors other than through the Southbound Stock Connect platform, and 2) the 71 dual listed-shares (A/H) that last October had reached an 11-year high average valuation premium of 50% in mainland China compared to their valuation in Hong Kong. A vast majority of these 71 stocks are state-owned enterprises, including all the big banks and insurance companies and all the large commodity producers.

The attraction for Hong Kong-listed mega caps that are all internet plays (Alibaba, Tencent, Pinduoduo, Meituan, JD.com) was triggered by the reappearance of Jack Ma, Alibaba’s founder who had “vanished” after the IPO of his fintech empire Ant Group got cancelled by the Chinese leadership in November last year.

Fortunately these very technical reasons, largely liquidity driven, have nothing to do with companies on the ground which, in general have been doing very well. Out of the approximately 4000 listed A shares in China, 1400 have issued preliminary results in January. This is a mandatory requirement if they foresee a profit rise greater than 50% YoY for the past year, if they turn from loss to profit or if they expect to record losses. 91% of those companies which fell compelled to make a preliminary announcement disclosed that their profit had risen last year by more than 50%. By comparison, Bloomberg is still anticipating earnings in China to have been down by 7.7% last year. This estimate looks now outdated.

We were not totally surprised by these preliminary announcements: All the industrial companies we have had discussions with over the past month are seeing a very strong activity. Many of them are currently working on three shifts as demand for Chinese products are boosted by the renewed lockdowns seen in the western world. It aligns with exports growth in December last year having been up by 18.1% YoY, driven by electronics, home appliances and furniture. The seasonally adjusted trade surplus of China in December was just slightly below its all-time-high reached the previous month at USD62bn.

The GDP growth of China was +6.5% YoY in Q4 2020, bringing the full year GDP growth to +2.3% in 2020. China had the second highest GDP growth in the world last year, behind Taiwan at +3.0% which is seeing its economy pulled by a very strong demand for microprocessors while its schools, offices and factories remained open throughout the year. It was the first time in 30 years that Taiwan saw its GDP growth exceed China’s.

For the first time in living memory, the Chinese government cancelled all Chinese New Year festivities this year as the country is seeing a resurgence of Covid cases in different parts of the country. It is requesting that all migrant factory workers provide a negative Covid test before leaving the province where they work, and it has imposed a 14-day quarantine on the way back. At the same time several cities have offered up to RMB1000 of cash handouts to workers who are prepared to remain in their factories, while labour laws provide for triple-wages to those who are being asked to work during public holidays. Given these restrictions combined with a strong industrial activity, the government expects a 40% drop in the number of travellers this year during Chinese New Year. The fact that factories will remain exceptionally open over this period should have a small positive impact on GDP growth in 2021 despite the negative impact on consumption and leisure-related sectors: The IMF is now forecasting a 8.1% growth this year.

The official manufacturing PMI of China has come down from 51.9 in December to 51.3 in January while the non-manufacturing PMI dropped from 55.7 to 52.4. This was below Bloomberg’s estimates and is the first sign of China’s strong post-Covid rebound coming to an end as the country is moving back to its normal growth path.

The pandemic has significantly widened the economic gap between North Asia and South Asia, in our views. Over the long term, the pandemic will most likely be a small blip on the growth path of China and Taiwan, with a short plateau on a rising long term trend. Korea will probably be a little more impacted after a year of negative growth (-1%) in 2020, but the recovery should be fast, driven by strong government stimulus and by export growth. The Korean economy should be back to its pre-Covid level growth path latest by the end of 2022. In South East Asia, the Philippines is probably the country where recovery will be the slowest. Even after a 5.6% QoQ growth in Q4 2020, the GDP of the country remains 8.3% below its level at the end of 2019. The pandemic is far from being under control and the geography of the country with its 2000 populated islands will likely turn vaccination efforts into a logistic challenge. Thailand and Indonesia will also need time to recover but it should be faster than for the Philippines. The challenge remains the re-opening of tourism that is so critical to the Thai economy. It is also likely that India will not be able to recoup its pre-Covid GDP level before the end of 2022 despite a GDP growth estimated by the IMF at +11.5% for fiscal year 2021/22 (2.7% higher than its previous projection dated October 2020) and following a 8% contraction in fiscal year 2020/21. As to the gap between the two superpowers, China is now expected to become the largest economy in the world in 2028 in real terms, five years ahead of what had been predicted by economists at the Brookings Institution (Washington, DC) and at the Centre for Economics and Business Research (London, UK) right before the pandemic outbreak. China already took over the US in Purchasing Power Parity (PPP) terms in 2013.

PORTFOLIO REVIEW

The start of 2021 was quite a month to watch. The first three weeks were a continuation of the bull run in 2020, full of euphoria. The MSCI China index was up by 16% at the highest, and the MSCI Asia was up by 11%.The markets turned south in the last week with no solid reasons other than the fear of expensive valuations.

Our portfolios underperformed during the month, even though the absolute performance was not bad. On the way up, our funds’ underperformance could be entirely explained by our underweight in the mega-caps names, i.e. Tencent, Alibaba, TSMC and Meituan, which were the ideal candidates to absorb liquidities. We understand well the risks of deviation from these names due to their enormous weight in the indices. Our strategy is to stick to our high conviction smaller and often non-benchmark companies to generate alpha over time. In the last week of the month, our conviction names began to suffer when the overall markets started to correct. Some of our star performers of 2020, such as Xinyi Glass and Li Ning, gave back some gains.

Throughout the month, our team’s key focus was to have direct dialogues with our portfolio companies to look back at 2020 and to review their positioning in 2021. We do these check-up calls/meetings at the start of each year, making sure our portfolio convictions stay high. We managed to speak to the vast majority of our portfolios holdings, and the outcome was very encouraging. To be prudent, we put Shanghai Henlius on our conviction watchlist. The stock performance has been disappointing. We will be monitoring their sales numbers closely to decide our next steps. We will also be watching closely Reliance Industries in India and Vitzrocell in Korea.

Amid the volatility, we made very few trades during the month. We added some Heifei Meiya and trimmed some China Merchant Bank and CICC in the China fund. We exited Tencent and Alibaba and added more to Poya, Aavas Financiers and Yum China in the Asia fund.

CHINA PORTFOLIO

La Francaise JKC China Equity saw its NAV per share rise by 2.7% in January when the MSCI China Free index rose by 7.4%. The cash position of the fund stood at 1.3% at the end of the month.

Top attribution contributors were Will Semi, going up 27% with a 5.5% average weight (index weight is 7bps only), and Bilibili, going up 33% with a 4.5% average weight (index weight 42bps). Our lack of Xiaomi which dropped by 12% with a 1.8% index weight, also helped. Our underweight on Tencent was the biggest drag. The stock went up 21% in the month benefiting from the southbound inflow (our average weight was 5.8% vs index 14.6%). Xinyi Glass with an average 4.7% weight dropped by 13% while Shanghai Henlius with an average 3.7% weight dropped by 15.7%, both hurting our performance.

On the news front, China Resources Beer announced a positive profit alert stating that its net profit would significantly increase by not less than 50% YoY for 2020. We focus more on the future outlook of its premiumisation strategy that is directly related to its acquisition of Heineken’s business in China. C&S Paper announced that it would invest RMB2.55 billion to build 400,000 tons of new capacity for high-end household paper in Jiangsu province to fulfil better demand in Eastern China, which we see as a positive move. SITC issued a profit alert as it expects the group to experience a substantial increase of 50% to 60% in net profit for FY20 compared to FY19. It implies that profit in the second half of last year has grown by 89% to 109%. We like this strong set of results as much as we like the outlook. Likewise, CICC estimates that its net profit for the year 2020 could reach as much as RMB6.8bn to RMB7.5bn,  representing a year-on-year increase anywhere between 61% and 78%. Hangzhou Tigermed announced its 2020 preliminary results with a recurring net income rise of 20-33% YoY. Wuxi Biologics also announced an unaudited 2020 earnings growth of 65% YoY, while stating that its strong growth momentum was likely to continue in 2021. At last Will Semiconductor announced that its profit had risen by RMB1.98bn to RMB2.45bn in 2020, an increase of 426% to 534%. After deducting non-recurring gains and losses, the net profit increase was even more impressive, +498% to 648% year-on-year.

ASIA PORTFOLIO

La Francaise JKC Asia Equity saw its NAV per share rise by 0.3% in January when the MSCI Asia ex-Japan index rose by 4.0%. The cash position of the fund stood at 1.3% at the end of the month.

Top attribution contributors were Will Semi, going up 27.2% with a 4.3% average weight (index weight is 2bps), Voltronic, going up 14.6% with a 3.8% average weight (out of the benchmark) and C&S Paper, going up 14.1% with a 4.4% average weight (out of the benchmark). Our underweight on Tencent hurt most. The stock went up 21% in the month benefiting from the southbound inflow (our average weight was 0.5% vs index 6.5%). Xinyi Glass with an average 3.3% weight that went down 13% and BTPS with an average 3.7% weight that went down 9.2% also dragged the performance.

On the news front, Poya announced its monthly sales numbers for December, which grew by 12.8% YoY to NTD1.6 billion. Samsung Electronics reported 4Q20 revenue of KRW61.6tn, +3% YoY, and operating profit of KRW9.05tn, +26% YoY. The company announced a KRW10.7tn special dividends and disclosed that it would pay out 50% of the next three years’ cumulative free cash flow. The company sees solid demand for server DRAM as customers have completed their inventory adjustment, adding that it expects the DRAM price to keep on rising in 1H21. TSMC reported 4Q20 revenues of NTD361.5bn, +14% YoY. Gross margin came in at 54%, beating the higher end of TSMC’s own guidance, thanks to a capacity utilisation close to 100% and a better product mix. Management indicated that its strong momentum was due to the ongoing high demand for high-power computing servers, to smartphone seasonality and to the recovery of automotive-related demand. Capex guidance for 2021 of USD25-28bn was the major upside surprise, comparing to USD17bn in 2020.

The information contained herein is issued by JK Capital Management Limited. To the best of itsĀ  knowledge and belief, JK Capital Management Limited considers the information contained herein is accurate as at the date of publication. However, no warranty is given on the accuracy, adequacy or completeness of the information. Neither JK Capital Management Limited, nor its affiliates, directors and employees assumes any liabilities (including any third party liability) in respect of any errors or omissions on this report. Under no circumstances should this information or any part of it be copied, reproduced or redistributed.

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