A guide to JPMorgan China Growth & Income Trust

They say the first part of recovery is recognising you have a problem – that is why there is hope that things may be starting to improve for the Chinese economy.

In late September 2024, The People’s Bank of China (PBOC) along with financial regulators announced a wide-ranging stimulus package that included interest rate cuts, more liquidity for banks, additional property reforms as well as funding initiatives for the stock market. The four areas of focus immediately raised hopes of a policy pivot with the market rising 24% in September 2024 alone*, before losing some of those gains.

But intentions must be followed by actions. The government must get investors off the sidelines and back into an economy which has been ailing for some time due to a regulatory crackdown, a tough Covid-zero policy and continued geopolitical uncertainty. Fears of a structural decline amid poor demographics, a collapsing property market and rising debt do not make things any easier.

But within this lies opportunity. Quite simply, China is too big to ignore. You only have to look at the Chinese consumer to see this opportunity – for example, family bank balances have increased 80% from the start of 2020. The net increase in household bank accounts is equal to US$9.2 trillion – to put that into context, it is greater than the GDP of Japan in 2023 and the value of China’s pre-Covid 2019 retail sales**.

Chinese equities look attractive from a valuation standpoint, trading at relatively low levels compared to historical averages and other developed markets.

JPMorgan China Growth & Income Trust (JCGI) has a 30-year track record of investing in Greater China, Hong Kong and Taiwan. Backed by a huge on-the-ground resource, the team, led by Rebecca Jiang, targets the growth potential of quality companies and focuses on fundamental, bottom-up stock selection. The final portfolio typically holds 60-80 stocks. Performance over the long-term has been very strong, but has struggled in recent years as internal and geopolitical pressures, coupled with a shift towards cyclically favoured stocks, has impacted returns.

Rebecca manages the trust with Li Tan. Rebecca is an executive director at JPMorgan and is a country specialist for Greater China equities and a member of the Greater China team within the Emerging Markets and Asia Pacific (EMAP) equities team. Based in Hong Kong, she joined the firm in 2017 after six years at Fidelity International where she was a senior equity research analyst. Li Tan is also an executive director and part of the EMAP team. He is based in Hong Kong and has worked at JPMorgan since 2011.

High quality, sustainable growth, but with an eye on valuations

The investment process is split into three stages. Fundamental research includes coverage of the universe of stocks, with the team focusing on three specific areas; a strategic classification of the business based on its economics, duration and governance; a risk profile analysis (which includes ESG measures); and a view on the company’s expected returns over five years. The second stage focuses on idea generation – which covers both quantitative and qualitative analysis. The final stage is portfolio construction, which blends multiple judgements to reflect the managers’ views on expected risk-adjusted returns and the conviction of each position in the portfolio.

The focus on higher quality businesses and growth opportunities has seen the team target three, long-term structural themes in technology, carbon neutrality and consumption. By contrast, there has been an underweight towards banks and energy. The income element of the portfolio was only introduced in 2020 and allows JCGI to pay an equivalent of 4% of the company’s NAV (net asset value), although this is subject to market conditions.

One of the key standouts is the huge resource of the EMAP Greater China research team at JPMorgan. This includes a Greater China team of 23 investment professionals. In 2022, JPMorgan acquired full ownership of its joint venture with Shanghai International Trust Co. in China International Fund Management (CIFM), bolstering its on-the-ground presence in the region.

As a result, they conduct some 1,600 company meetings each year, with an in-depth focus on 550 Greater China stocks (including 250 A-shares).

Why now for this portfolio?

• JCGI has an excellent track record, returning 76.8% (vs. 56.9% for the MSCI China Net Dividends Reinvested) over the past 10 years***.
• The trust has been out of favour due to numerous issues beyond its control – these include rising geopolitical tensions, a lacklustre economy and a rising interest rate environment (favouring cyclical stocks). The trust’s value has almost halved on both a share price (-49.3%) and NAV (-46.3%) basis***, while the discount on the trust is currently at 14.1%****.
• A focus on high-quality growth companies – with technology, carbon-neutral and consumer-related businesses all strong themes
• A market-leading, on-the-ground presence in the region – giving them excellent access to companies.
• Pays a dividend of 4% of the company’s NAV – subject to market conditions.

Manager’s View

“The recent policy change is a meaningful pivot and has set a strong valuation floor for Chinese equities. But for us to see meaningful upside we need to see more policy measures, particularly towards property and construction. But there is urgency among the government, so I’d expect more to come quickly.”

Although there have been plenty of concerns plaguing the Chinese economy, Rebecca says the biggest has been the major property down cycle – which has seen property prices fall 20-40%. This has put significant pressure on macroeconomic growth because property and property-related industries accounted for a third of China’s GDP. To offset this, the government went down the path of stimulating manufacturing growth through capital expenditure and exports. This helped when Covid started to impact the global economy as China was open earlier in the initial stages of Covid, allowing it to take market share.

She says: “The property downcycle is still ongoing and has not found a solid bottom, which puts pressure on overall GDP growth. Secondly, the key growth drivers in the shape of manufacturing and exports are increasingly facing challenges going forwards. This is due to geopolitical challenges with the US and other markets, like the EU.

“Large-scale investment has gone into manufacturing over the past five years and we are seeing overcapacity in certain sectors, which has impacted the overall profitability of the space. With hindsight, we can also see that valuations were very high four years ago, while the rising interest rate environment we’ve seen favours cyclical stocks.”

The favour towards value stocks is reflected by the MSCI China Value Index falling only 4% in the past three years, compared with a 31.5% loss for the MSCI China Growth Index^.

Rebecca says the past couple of months have seen a lot of potential change come out of China – with the government finally acknowledging the “challenges are real and harming the economy”. She hopes this is the start of actual change which supports JCGI’s focus on good quality companies offering consistent capital appreciation.

What impact have the recent announcements had on the portfolio?

While Rebecca acknowledges this being a meaningful pivot, she says what we have seen so far is market movement driven by valuation changes – with a muted impact on earnings from the policy announcements.

She says: “We’ve not made big changes to the portfolio on the back of the stimulus. We were positioned in a way that we thought valuations were too cheap and share prices have priced in a lot of pacifism, particularly from a cyclical perspective. So we went into the policy pivot with portfolios that were tilted to macro-sensitive sectors (consumer-facing businesses in particular), something we were quite happy with.”

Since the policy announcements were made, the trust is up 14.6% and 17% from a share price and NAV perspective respectively^^. The team have used the subsequent volatility to take profit in some of the cyclically-tilted names, such as property-related businesses. “We had a large overweight and some of the stocks had risen 50%,” Rebecca adds.

The team have focused that property exposure on companies with strong balance sheets. A good example is KE Holdings (Beike), which is a property agent in the primary and secondary market. Rebecca says it is an agency model, which is asset light with a strong balance sheet. Another is Mixc, which operates mall companies in China.

The team also maintain consumer-related positions in the property sector, such as home appliances. These are businesses Rebecca views as both cash generative and operating in a market structure which is very solidified.

Tariffs and rates – danger and opportunity

Potential tariffs remain a significant concern for the Chinese economy. During the 2016–2020 Trump administration, the average tariff on US imports from China rose to 17% from 4%. If the current proposal for a 60% tariff on China was fully implemented, the incremental tariffs on imports from China could represent more than $230 billion annually (1.3% of China’s GDP in 2023)*.

Rebecca says the focus remains on bottom-up selection rather than trying to second guess the Trump administration, but there are a couple of factors which offer relief. Firstly, although Trump is likely to impose tougher tariffs, she says Chinese companies have diversified their supply chains significantly since the trade wars began. Rebecca says the team have also been looking for opportunities from companies benefitting from the de-coupling of China and the US – this is particularly true in the technology space given the restrictions on advanced technology access (semiconductors for example).

One of the reasons JCGI has struggled in recent years is the rising interest rate environment seen in 2022-2023. This resulted in cyclically-sensitive stocks outperforming. Rebecca says the move to a rate-cutting environment should naturally help JCGI. She says China’s domestic rates will trend down, with the Fed’s changes in rate policy offering the People’s Bank of China (PBOC) greater flexibility on domestic rates and foreign exchange.

Portfolio activity and attribution

As mentioned, the search for high quality growth has seen JCGI favour technology, a sector where they have had a meaningful overweight (14.6% vs. 5.8% for the benchmark). Additions in the past 12 months have included the likes of BOE Technology (an electronic components producer). Other overweights include industrials (8.1% vs. 4.8%) and healthcare (6.2% vs. 3.8%)^^^.

A notable underweight has been financials (6.5% vs. 16.7% for the benchmark) – an area which has benefited from the cyclicals rally^^^.

Some of the biggest contributors to the portfolio in 2024 include Meituan, a Chinese shopping platform for locally found consumer products and retail services including entertainment, dining, delivery and travel. Rebecca says: “Meituan is a good example of the improved adaptability of companies in China. They used to invest heavily in new businesses like group purchases for fresh products, which was loss making. We’ve started to see the company proactively reduce losses in new business initiatives – which was welcomed by the market.”

Rebecca says this adaptability is a wider theme in China in recent years – citing more companies having nimbler cost structures as well as being more selective on investment opportunities.

We mentioned the underweight to financials – but this has narrowed in the past 12 months, due to low valuations. One such addition to JCGI has been insurance company China Pacific Insurance. Rebecca says the company has gone through an element of reform, with both its investment and protection products being popular. She says the stock is still cheap, but the recent re-rating has helped performance.

By contrast, a major detractor is Chinese pharmaceutical company WuXi Biologics. Rebecca believes geopolitics has caused great uncertainty within the business and sector. WuXi is a contract research organisation that provides research services to global pharmaceuticals, including US pharmas and biotech companies.

She says: “Poor performance has been the result of this company and its sister (WuXi Apptec) being targeted by US politicians as a national security concern. There is a bio secure act that has passed the house in the US, but is still pending senate votes. This is a pact that calls to ban WuXi serving US clients for reasons I do not agree with. It is being banned for perceived risk to US biological data securities – which I believe is invalid. This is a key reason why the stock was heavily sold off.”

Performance in a tough environment

The past three or so years have been incredibly challenging for the trust as geopolitics (tariffs, wars), a move away from growth towards value, the collapse of the property market and a stringent Covid policy have all been major headwinds. Even having little exposure to state-owned enterprises has been a headwind, given they have had backing from the government in these uncertain periods.

The preference for secular growth businesses should mean they deliver over the long term, but they are far from immune from market downturns. JCGI’s value has almost halved on both a share price (49.3%) and NAV (46.3%) basis over three years, compared with an 18.1% loss for the benchmark***. Over ten years the trust does remain ahead of its benchmark, returning 76.9% and 75.6% on a share price and NAV basis respectively (vs. 56.9% for benchmark).

A lot of the damage is due to sentiment, with Rebecca citing EV battery maker CATL as an example. She says the company has improved its competitive position in the past 3-5 years (it is now the world’s largest manufacturer of EV and energy storage batteries), but the valuation has been hit purely on sentiment rather than earnings. She says: “CATL are now in a much stronger position globally compared to three years ago; particularly when compared to global competitors. They’ve also proven in the past couple of years that they have extremely strong pricing power and also stability in their profitability/margins. Cash flow has also significantly improved. All of this has been overridden by poor sentiment.”

What else do investors need to know?

JCGI can use gearing up to a maximum level of 20% of shareholders’ funds to increase potential returns to shareholders. Gearing has been as high as 15.6% in the current financial year, but is currently at 6%. The gearing fell in the latter half of 2023 due to volatility impacting JCGI’s NAV, resulting in a breach of its loan covenant (the board repaid some of the loan to address this).

JCGI continued to utilise its facility agreement with Industrial and Commercial Bank of China Limited, London Branch (ICBC), in respect of a revolving loan facility of up to £60m. Due to market movements and after discussions with ICBC, the Company’s loan agreement was amended in March 2024 and the facility was reduced to £30m. There is currently £9.2m drawn down on the existing loan facility, which expires in July 2025.

The dividend policy targets an annual dividend equivalent to 4% of the company’s NAV on the last business day of the preceding financial year. The target dividend is announced at the start of each financial year and paid by way of four equal interim dividends on the first business day in December, March, June and September. These dividends are paid from a combination of revenue and capital reserves.

JCGI is currently on an attractive discount of 14.1%, more than double the average discount (6.7%) over the past five years)****.

Outlook

Challenging times but policy announcements provide hope

Hope springs eternal that the policy announcements made by the PBOC in September 2024 are the start of a change in fortunes for the Chinese economy, after what has been an incredibly challenging four years. Getting the consumer to start spending and tackling the troubled property market are just two of the major challenges facing the economy – but the important thing is the government has recognised it has a major problem.

JCGI has faced significant headwinds in the past few years – but it continues to have a strong, long-term track record. Despite some recent positivity, valuations remain cheap and the trust is on a very attractive discount. JCGI is a proven long-term performer, with market-leading on-the-ground expertise. The team believe things have started to turn, and while there may be volatility, their focus on high quality growth companies means this could well be an attractive entry point, particularly as companies in the region adapt and evolve.

*Source: Lazard Asset Management, Emerging Markets Outlook Q4, 2024
**Source: Matthews Asia, 7 October 2024
***Source: JP Morgan/Morningstar, as of 31 October 2024
****Source: FE Analytics, as of 28 November 2024
^Source: FE Analytics, total returns in pounds sterling for MSCI China Value and MSCI China Growth, 26 November 2021 to 28 November 2024
^^Source: Association of Investment Companies, as of 28 November 2024
^^^Source: JPMorgan, as of 30 September 2024