Fund Commentary - Allianz China Equity
Investment Objective
The Fund aims at long-term capital growth by investing in onshore and offshore People’s Republic of China (“PRC”), Hong Kong and Macau equity markets.
What Happened in October
The China A share market fell by more than 10% in October, which was a result of a combination of global macro factors such as US/ China trade tensions, as well as idiosyncratic issues relating to domestic China A shares, in particular the issue of pledged shares.
In particular, many of the previous foreign favourites within China A-Shares faced significant selling pressure in October, especially within consumer areas. Among the top detractors, we have the largest yeast manufacturer in China. The company suffered from weakness in profit margin due to production suspension for environmental reasons. We believe this is a one-off event, which will likely impact near term earnings; however, we expect long term growth to normalize given the dominant market share, strong management execution and solid business strategy. Without limited catalysts in the near term, we slightly reduced some position in this name, but remain optimistic over the long term.
With the recent slowdown in retail growth in China, we are very selective in this space. For names that are highly sensitive to the real estate sector, including furniture and home appliance names, we tend to be more cautious. On a more positive note, we continue to see structural growth potential for companies that can benefit from consumption upgrade including travel and entertainment, high end products, new retail, etc.
On the positive side, one of the top contributors was Luxshare Precision, a connector manufacturer supplying to consumer electronics products. We maintained our conviction in this stock even after its share correction in the previous month, as we believe the company should continue to gain content value within the existing client base, and have the potential to expand into new business segments. The company’s share price recovered in October from oversold valuations and we believe this is a high quality name within the hardware space which should outperform peers over time.
Market Outlook and Strategy
Since late September, both the onshore and offshore markets faced renewed selling pressure, induced by poor global markets and domestic concerns over the trade war and a slowdown in economic growth.
In particular for China A-Shares, market correction was amplified by the stock pledge loans, where company management, who are typically the controlling shareholders, have pledged large quantities of their stock as collateral against loans from brokerages. As the downturn in the China A markets has deepened, there have been growing margin calls. This, in turn, has raised fears of a downward spiral in which brokerages liquidate the collateral to recoup their losses, sending prices down further and sparking more margin calls.
We believe such technical reasons helped partially explain the performance gap between
onshore and offshore China so far this year. After such correction, the valuations of many
China stocks are trading at attractive valuations, especially for those names with structural
growth potential and strong market positions. For example, we have been adding to import
substitutors, i.e., those companies that continue to gain domestic market share from foreign
players, with competitive quality, reasonable pricing and strong local network. The recent
correction in healthcare names also allowed us to add biopharmaceutical names on
weakness.