November 2019

The bullishness investors had was put to the test in November as markets grew increasingly nervous about the phase one of a trade agreement between China and the United States, with no signing of an agreement being announced despite both parties saying repeatedly that a deal was very close. There were more down markets than up markets in the region with the MSCI Asia ex-Japan index remaining roughly flat for the month. There was a notable divergence between the Shanghai Shenzhen CSI 300 index (-1.9%), the Hang Seng Index (-2.1%) and the MSCI China index (+1.7%). The key reason behind the divergence was technical: Alibaba which is the largest constituent in the MSCI China index with a 17.1% weighting gained 13.7% as a consequence of its Hong Kong listing, whereas the Hang Seng Index and the CSI index do not include Alibaba.

It remains our view that the last batch of tariffs that is supposed to hit all exports from China to the US of mobile phones and electronic devices (including computers) on 15th December with a 15% duty is not going to see the light of day, and will likely be postponed before being eventually cancelled. Markets also became very jittery as President Trump signed the Hong Kong Human Rights and Democracy Act that was literally imposed on him by the US Congress, not that he had much of a choice when came the time of signing it. China seems to have understood the position Trump was in on that issue as the official reaction was rather muted. It is also not in any countrys interest to pour more oil on fire at this advanced stage of negotiations. Going forward, a review of Hong Kongs human rights will have to be performed once a year by the US administration and, in case of abuse being reported, any sanction against Hong Kong officials would have to be decided by the President of the United States, giving him/her additional leverage when negotiating with China. For the time being, it all looks rather symbolic to us as, hopefully, tension between the two countries will have subsided by the time the first review is performed. The reason for bringing this bill to Congress was the level of unprecedented violence we have witnessed in the streets of Hong Kong that ended – permanently or temporarily is impossible to guess – with local district council elections being organised giving pro-democracy candidates control over 17 out of 18 Councils, and 117 seats out of the 1,200 that select Hong Kongs chief executive.

The other big event of the month was the listing in Hong Kong of Alibaba which became the largest company of the local market, with a market capitalisation of USD540bn at the end of the month (Tencent is now second with a market capitalisation of USD405bn). Alibabas share price gained 12.7% over its six trading days of November. Because of its unequal voting rights structure it might take up to seven months for mainland retail investors to finally be able to buy into it using the Stock Connect platform, unless regulators amend their own rules. Given the notoriety of the company and of its founder Jack Ma in China, it is a reasonable assumption to make that retail demand will be very strong when that happens.

The domestic China market is gradually benefitting from the rising ownership of A-shares by foreign investors as MSCI just went through the third stage of inclusion of this market into its indices. The weighting of A-shares in the MSCI Emerging Market index quadrupled in November to reach 4.1%. Foreigners now own 3.2% of the Shanghai and Shenzhen markets, more than twice as much as what it was two years ago. The inclusion factor of MSCI has just risen to 20%, meaning that the weighting of A-shares in MSCI indices will ultimately be five times greater. The A-share market of China is the second largest market in the world with a total capitalisation of USD6.75 trillion (Hong Kong is fourth at USD5.20 trillion, and Japan stands in between).

Last week the Indian government announced the setting up of a 250 billion rupee (USD 3.5bn) fund to help rejuvenate stalled residential projects as part of a bid to reverse the slowing growth of the economy. 100 billion rupee will be contributed by the government whilst the remaining 150 billion rupee will come from State-run insurer Life Insurance Corp, State Bank of India and other government-related entities. Unlike previous housing funds, the government aims to also support projects that have been written off by lenders as bad loans. The announcement of this fund is likely to benefit the banks and the Non-Banking Financial Companies (NBFC) that lend mostly to the housing sector. NBFCs have been experiencing a funding crisis since Infrastructure Leasing & Financial Services (ILFS), a large infrastructure fund defaulted last year. This new fund should create some sort of backstop for troubled NBFCs that are at the core of the financial crisis that India is currently going through. As a result of this headline, we saw many NBFCs bonds rally, together with many banking stocks. Indusind Bank which we are exposed to gained 20% in November. Whilst, we see this headline as a positive development for the sector, we remain cautious as execution remains a key consideration going forward.

ASIA PORTFOLIO

Top performers were Indusind Bank (+19.7%), Alibaba Group (+13.7%), and Hansol Chemical (+7.7%). At the other end of the spectrum, the weakest performers were 3S Bio (-23%), Chroma (-8.5%) and Hangzhou TigerMed (-8.1%). During the month, we increased the weighting of the portfolio in 3S Bio, AIA Group, ASM Pacific, SK Hynix, Hefei Meiya and Ace Hardware. We took some profit on Ping An Insurance. We added one new name Voltronic Power in Taiwan, and exited China Mobile.

During the month, the biggest mover in the portfolio was 3SBio, the biological drug maker which lost 23%. As part of the ongoing healthcare reforms, the Chinese health authorities published in November a list of additional drugs to be included in the National Reimbursement Drug List (NRDL). The patient base for drugs on that list typically increase significantly after they are added. One of 3SBios main products, Yisaipu (20% of sales) that was until now the only drug in the NRDL to treat rheumatoid arthritis and Crohn’s disease saw a competing product included in the NRDL, Humira produced by US company AbbVie. Even though Yisaipus price will likely remain competitive compared to Humiras, investors are concerned that the competition would lead to a gloomy outlook for Yisaipu. We will monitor the actual sales of Yisaipu closely, but we are of the view that the inclusion in the NRDL of a competitive product will force the two companies to cut their selling price making these drugs more affordable for the general public, leading to a surge in volume growth as we have seen in many similar situations. For the ultra-expensive drug category which Humira and Yisaipu belong to, the inclusion will significantly expand the addressable market from an extremely low base today. It should be a win-win situation for both drugs. In other words we are of the view that the market overreacted.

Elsewhere in Asia, VitzroCell, the Korean manufacturer of primary batteries reported its 2019 third quarter results with revenues going up by 29% YoY, gross profit increasing by 15% YoY, and net profit going up 52% YoY driven by a strong control of operating expenses. Koh Young, the Korean semi-conductor equipment maker saw its revenue growing by 3.5% QoQ in the third quarter, backed by strong demand from Chinese mobile clients for 5G. Net income of Koh Young went up by 9.1% YoY. We are of the view that the semi-conductor equipment industry, including both manufacturing and testing, has reached its trough and is on the rebound. This is our conclusion after going through the latest comments made by giant chip makers TSMC and SK Hynix which provided bullish outlooks for 2020.

CHINA PORTFOLIO

Away from Alibaba, the biggest mover of the month in the portfolio was 3SBio which is mentioned in our Asia portfolio section. Another major news was AIA, the insurance company, poaching the co-CEO of Ping An Insurance to become group CEO and president of AIA in anticipation of the retirement of its current CEO. After having been founded in Shanghai in 1919, AIA moved its headquarter to Hong Kong in 1931 to become a pan-Asian insurance leader. It is categorised as a foreign entity by Chinese authorities. With the opening up of the China insurance market to foreign players, AIA today has China as its main engine of growth. By hiring at a high price the most senior executive of the most successful Chinese insurer to become its own CEO, AIA is clearly indicating to investors where it sees its biggest growth opportunity going forward. AIAs share price was flat in November when Ping An Insurance lost 2.3%. We own both companies.

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