Lilian Co sees further upside for Chinese equity markets

The Morningstar five star rated* EI Sturdza Strategic China Panda Fund returns 63% in 2017, and Lilian Co believes the market has room for a further rebate in the short to mid-term.

Fund Commentary
1 Mar 2018

The Morningstar five star rated* EI Sturdza Strategic China Panda Fund returns 63% in 2017, and Lilian Co believes the market has room for a further rebate in the short to mid-term.

Market View

Lilian Co, portfolio manager of the EI Sturdza Strategic China Panda Fund (the ‘Fund’), highlights that the exceptionally strong run for the Chinese equity markets in 2017 represents a “revision to mean” given that valuations came into the year at depressed levels. When asked whether 2017 growth was exaggerated she explained: “No, an overstatement was the undervaluation of Chinese equities starting in 2015 as investors in the US and Europe constantly worry about a crash in the economy and the stock market.”

This meant that Chinese equities were trading at single-digit P/E’s, whilst offering decent returns. Investors however remained sceptical regarding the growth potential for the Chinese market, with lingering concerns as to whether the market would be subject to a hard landing. This scepticism leads to an under-appreciation of the quality of Chinese assets and their growth potential, resulting in the market being penalised by international investors, who retained a structural underweighting. 2017 highlighted the strength and quality of earnings growth, supported by domestic inflows to equity markets.

Lilian believes that the negative effects of the reforms within the Chinese markets are now reaching an end and that the Chinese companies have been able to demonstrate their strength as a result of a corporate earnings recovery, attributable to structural changes which have been implemented, rather than a cyclical upturn.

From a longer term, macroeconomic point of view, Lilian believes that China remains underweight in the majority of international investor portfolios, that China continues to strive to open its markets, which will have a long term beneficial impact and that the market will become increasingly interesting to foreign investors once attention refocuses on corporate earning growth, rather than a pure “China” macro / cyclical view, stating: “On closer inspection, investors who are still sceptical will realise that the Chinese stock market has long since emancipated itself from the typical boom and bust cycles and is now driven by corporate earnings growth rather than macroeconomic and cyclical assessments.”

Lilian expects growth in China to moderate in the coming years; however still to be in excess of other global markets. Key however in this context is for investors to adjust their mindset and to focus less on GDP growth and to instead look at the quality and sustainability of corporate earnings growth. Lilian believes that the market is well positioned to deliver further upside over the medium term as financial deleveraging continues and sees no hard landing risks.

Fund Approach and Positioning

The team continues to look for growing companies which are trading at reasonable prices, looking to capitalise on mispricing opportunities, studying earning forecasts, which they believe can provide indicators of potential opportunities when they differ from the market consensus. This is then combined with a fundamental bottom up stock selection process and results in a concentrated portfolio of between 30-40 stocks, taking active single stock and sector bets.

Against the backdrop of the above macro view, the Fund’s portfolio is currently being focussed towards themes / sectors that have high levels of growth momentum, resulting in active overweight exposure to; Consumer Discretionary (+28.73% relative) and materials, whilst being notably underweight Financials (-13.34%) and IT. Whilst IT is underweight on a relative basis, this remains the Fund’s second largest exposure at the sector level, representing 33.42% of the portfolio as at the end of December 2017, with 4 of the top 5 holdings being within the sector, with Tencent remaining the Fund’s largest position.

Lilian provided the following comments on the stock in a recent interview with Investment Europe:

“Tencent remains a large position in the Fund. We are unfortunately underweight because Tencent represents about 18% of the MSCI China index and we are constrained by UCITS-compliance rules in the Fund (maximum holding of 10% for any stock). Alibaba is another big play for the fund. We are also heavily weighted in other Chinese technology companies.

Tencent is the largest social network in China and does not have competitors. Some 40% of its revenue is derived from mobile games but the biggest competitive edge of Tencent remains its platform. There are still pockets of Tencent’s platform, such as mobile online advertising, that are either under or not monetised in our view. Tencent goes from strength to strength. Everybody owns it because you cannot afford to avoid the MSCI China’s largest constituent. Is the stock a crowded trade yet? I do not believe so because a number of UCITS mutual funds are underweight Tencent.”

Investment Growth

Time Period: 04/10/2008 to 28/02/2018
Peer Group (5-95%): Open End Funds – Europe / Africa / Asia – Greater China Equity.
Currency: US Dollar. Source Data: Total Return.

Source: Morningstar Direct

Fund Performance %

  1Y 3Y 5Y Since
Fund 56.64 62.34 77.79 275.31 15.10
MSCI China NR Index 46.71 42.89 68.76 157.24 10.57

Performance data as at end of February 2018.

Fund Enquiries

If you require any additional information regarding the Strategic China Panda Fund, please contact:

Adam Turberville
Head of Client Relations
+44 1481 722 322

Further Insights from Lilian Co

Lilian Co explains why China’s ‘New Economy’, a term she uses to describe the region’s growing technology, healthcare and education sectors, is likely to lead the market to sustained economic growth over the longer term.

Lilian Co provided insight regarding her optimism for China’s economic trajectory and the opportunity for sustained growth.

In this webcast: Exploring the Opportunity Presented by Chinese Equities – Lilian Co provided insight regarding her optimism for China’s economic trajectory and the opportunity for sustained growth.

We now offer Swiss investors the opportunity to invest in China’s fast-growing equity markets by offering a fully hedged Swiss Franc Class of the fund.

“You can’t avoid Tencent” – Read the Investment Europe article (as referred to above).

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