The potential risks and outlook for Chinese equities in 2022

Rebecca Jiang, co-manager of the JPMorgan China Growth & Income Trust, joins us to discuss Chinese equity markets in 2022. After an awful 2021, Rebecca shares her views for the outlook of Chinese equities, the risks to consider and the trusts dividend target.

In this interview, Chris Salih talks with Rebecca Jiang, co-manager of the JPMorgan China Growth & Income Trust. After an awful 2021 for the Chinese stock market, Rebecca shares her views on the outlook for Chinese equities, the risks to consider and the trust’s dividend target.

Please Note: Below is a transcript of the video, modified for your reading pleasure. Please check the corresponding video before quoting in print, as it may contain small errors.

Let’s start off with the challenges in China. It’s been a difficult 2021. The markets have been down 30% or so over one year. But, looking at the portfolio, it still looks fairly aggressive. You have 37% in China A-Shares, half the portfolio in Hong Kong listed Chinese companies, and gearing is still reasonably high. The trust has also bounced back very well in the past month or so. Could you maybe give us a snapshot? Has China finally turned the corner and are you more positive on the market from here on in?

[00:45] If I could just take a step back and think about China from more of a global perspective, China has really decoupled from the rest of the world ever since the outbreak of COVID. So, if we look back at 2021, while most of the major economies were still increasing stimulus because of COVID, China was actually withdrawing stimulus during that period of time. And on top of that, they had targeted tightening on a couple of important industries, namely property and internet.

Now fast forward to this year 2022, we know that most of the major economies globally are fighting with inflation and central banks are basically tapering and hiking rates. And we’re seeing China being on the opposite side again – the PBOC, the central bank of China, is loosening monetary policies. The government is also stepping up fiscal stimulus and we’ve seen the government conclude most of the regulatory actions on property and internet. So, this makes the China market particularly interesting in the current global environment, because of the counter cyclicity of both the economic and policy conditions.

This comes from a 30% draw down that we’ve seen three months ago, which has made valuations extremely compelling. And after the reason bound, as you noticed, the market is still down 30% from a year ago. But the long-term story of China that we believe in, comes from high GDP growth, as well as abundant bottom up opportunities and remains unchanged, particularly the China A-Shares which is the offshore market of Chinese equities. They still offer a vast opportunity set of interesting individual companies.

And in terms of the market turning in the past couple of months, how has the portfolio turned in tune with that? I mean, you can invest in the likes of Greater China, Taiwan, which are perhaps generally more defensive. Have you been selling those and moving into more aggressive parts? Just give us a snapshot of the portfolio as we speak at the moment. Are you as positive on China, or more positive than some of your peers? Just give us a bit of an insight into your outlook at the moment.

[03:33] Sure. We have been long term China believers who have been positive on Chinese equities from a long-term perspective. And we have probably stayed close to maximum gearing over the last three quarters or so, and the few Taiwan-listed companies that the trust owns, they are mostly Chinese companies either listed in Taiwan or have the majority of the business coming from China. But on the margin, we have been tweaking the portfolio towards two areas. One is sectors that have been negatively impacted by regulatory actions last year, which are mainly internet and property and property-related businesses. The other area that we have been adding bets towards our China stimulus sensitive names, mostly in renewable energies and smart infrastructure.

And to follow up on that on the first point with regards to the areas that have been affected by the likes of property and internet, do you feel they’ve been overly sold-off or has this been an overreaction to the news?

[05:05] We’ve definitely seen a settling down of regulatory framework around the sector and arguably the sectors have been growing under a relatively loose regulatory environment over the last decade. And China, throughout the last one or two years, has been quickly catching up with the Western market when it comes to regulations around these sectors – things like protection of consumer data, privacy, as well as regulating on monopolistic behavior, corporate behavior. Now, at this point in time, we feel that most of that regulatory framework has already been set up. So, a lot of the uncertainties around future regulation is now more or less being removed. Also, because of the regulation, we’ve actually noticed that a lot of the smaller players and irrational competition have now been cleared out of the markets, which has resulted in a significant improvement in profitability in some of the businesses that the trust invests into, simply because the competitive landscape has improved a lot. And this comes on top of the valuation point that I talked about.

Generally speaking, we are quite positive on the sector as a whole, but as bottom-up stock selectors we have different assessments on different companies, so we do not treat them as one homogeneous sector. But certainly, there are a lot of interesting opportunities within the sector.

The trust also pays a dividend. Could you maybe talk us through the process behind that and the level of income it looks to achieve?

[07:23] The board of the trust firmly believes and wanted to deliver stable income to the trust investors. So, the board aims to pay out dividends based on 1% of the NAV on a quarterly basis. This, on the other hand, doesn’t impact the way that we manage the fund, so the natural yield of the portfolio at the moment is somewhat below 1%. So, this remains to be a very growthy portfolio. Anything above the natural yield, that will be paid off out of capital gains.

And finally, in terms of the China recovery that we’ve seen recently, could you talk us through the potential risks and the future potential – do we always have to be prepared for the government’s potential to interfere and are geopolitical concerns still rife in the region?

[08:36] The biggest risk on my mind on a short-term basis is actually related to COVID or more precisely China’s COVID policies. We know that China has been sticking with ‘COVID zero’ for two and a half years now. While we have seen some relaxation more recently on COVID control measures, for example I’m actually currently in Beijing on my second last day of home quarantine. Beijing actually has cut down the number of quarantine days from 21 to 10 days at the moment. That happened within the last month or so. So, we definitely have seen some fine tuning of the extremely stringent COVID control policies. However, China hasn’t really revealed a comprehensive COVID exit policy yet at the moment, so we are expecting that zero COVID to be around at least for a while.

This is probably the biggest uncertainty for investments in China. The Chinese government is dealing with a highly contagious and fastly-mutating virus, which impacts a vulnerable population much more seriously. So, it’s a tricky problem that they’re dealing with.

At the moment, we feel that they have made certain tweaks, and they are prioritising economic stability and growth which is positive to the equity markets. But this is from my perspective, one of the biggest risks that investors should bear in mind.

I actually think that the two risks you mentioned – government interference and geopolitics – are tricky questions or tricky problems, but also there is something here to stay and there are always two sides to every story.

I talked about how a lot of the internet companies that the trust invested into are seeing margin improvements because of regulation forcing out a lot of the irrational competition. Similarly, when you talk about geopolitics, we’ve actually seen geopolitics driving import substitution and increasing self-sufficiency in a lot of the areas, particularly technology-related, and that has benefited a lot of local Chinese companies. So really those are tricky questions that we need to think about. But we have seen both opportunities and challenges arising from those aspects.