Fund Friday: Where will China's next leg of growth be? The answer lies in its domestic consumers.

• China’s recent slew of positive economic data lends support to the notion that it will continue leading Asia, and the rest of the world, out of the current economic malaise
• Recovery in domestic consumption and exports have been robust following the easing of lockdown measures
• Consumer stocks in particular have performed well. China’s reaffirmation of its pivot and shift towards domestic consumption and higher value add services and manufacturing, is a plus for consumer stocks over the long term.
• We believe our recommended China equity fund, JPMorgan Funds - China A (acc) SGD, is one way to gain exposure to the various consumer related growth themes for 2021 and beyond

China is the best performing single-country market in 2020. In ‘Can the best-performing equity market this year sustain its stellar returns?’, our macro research team covered on the various reasons why the Chinese equity market can continue to run higher, despite its strong performance thus far. One of the key reason as outlined in the article, is the strong ongoing recovery that China is experiencing, that places the country well ahead of the global economy.

Recent economic releases spell positives for the Chinese economy

While the prospects of China losing its status as a global manufacturing hub has been the talk of the town, recent export data suggests otherwise. The pandemic has shown that China firmly remains as the chief manufacturer for the world (especially the US), as its ability to reopen its factories safely, contrary to the rest of the world, has been a key driver for its strong recovery observed thus far.

Chart 1: While the world remains closed, China’s factories are open for business

With the successful subjugation of COVID-19 transmission cases in China, economic activities for the country has also begun to normalise and recover. Consumption has been a key area of strength. Household consumption for various consumer categories have seen marked improvement over the previous quarters. Retail sales on aggregate have also been on an upswing.

Chart 2: Consumer spending takes a V-shaped recovery in some areas; laggards likely to play catch up in coming months

The early normalisation in economic activity is a great positive for China’s domestic consumption, which for most parts of 2020, has been negatively impacted by pandemic restrictions. Strength in consumption trends reaffirm our belief that Chinese equities can continue to do well in 2021 even if supply-side policies (e.g. property & infrastructure spending) enacted earlier this year cool off.

We remain favourable on the prospects of the Middle Kingdom, given its relative resiliency in the current global economic malaise. With other major economies likely reopening their economies successfully in 2021, we believe China’s current economic growth and momentum will continue to power through. We also expect growth in corporate earnings of Chinese companies to trend in the same direction.

About JPMorgan Funds – China Equity Fund

JPMorgan Funds - China A (acc) SGD is our recommended fund for Chinese equity exposure, under the core China equity category. We believe it is one of the best products available on the platform to gain exposure to the burgeoning consumer in China.

The fund is co-managed by Howard Wang and Rebecca Jiang. Other funds managed by the both of them include JPMorgan Funds – Greater China & JPMorgan China A-Share Opportunities, all of which have very strong track records.

(Investors are encouraged to use our Fund Selector tool to compare the performance of various funds on our platform.)

One unique characteristic about JPMorgan Funds - China A (acc) SGD over other peers is its ability to invest more towards the onshore equity market. The fund may invest a maximum of 40% of the fund’s AUM into A-shares. On the contrary, most other peers, in accordance to their investment mandate, may only invest up to 10-20%.

This is perhaps an important distinction for the investor who wants to capture growth in the trend of rising consumption in China. The A-share market has a higher representation of consumer-related stocks and tends to be less sensitive to changes in foreign market conditions.

The fund’s main objective is to identify and position for fast growing and high quality companies in China. At present, such characteristics tend to be found more in companies within technology, consumer, and healthcare sectors. Therefore, the fund’s exposure is likely to have a greater emphasis in these areas.

But of course, as an all-China fund, investors can certainly expect a holistic exposure to Chinese companies. Generally speaking, the fund will avoid investing in state-owned-enterprises (SOE) as they are often more wasteful in their capital allocation decisions. Therefore, when picking financials and banking related companies, for instance, the fund is more likely to own more exposure of non-SOE companies.

Table 1: Fund’s top ten holdings

Top 10 Holdings in Portfolio	%
Alibaba	9.8
Tencent	9.6
Meituan Dianping	5.8
Ping An Insurance	5.4
China Merchants Bank	2.9
WuXi Biologics	2.7
NetEase	2.7
Kingdee International Software	2.1
New Oriental Education & Technology	2.1
Ping An Bank	2.1
Total	45.2

Source: JPMorgan Asset Management

Data as of 30 September 2020

JPMorgan Funds - China A (acc) SGD is managed with a high conviction approach, holding anywhere between 40 to 55 stocks in its portfolio. While the fund managers are mindful of top-down/macro considerations, stock selection (at least in recent times) had contributed to most of the fund’s active returns.

Besides having a longer growth runway, the fund also generates higher return on equity for shareholders (as seen from the table below) despite exhibiting lower underlying leverage, clearly highlighting the quality aspect of its portfolio. Certainly, the aggregate stock portfolio’s valuation tends to look rich as investors ascribe a high premium to own stocks with such desirable attributes.

Table 2: Fund portfolio metrics

Portfolio metrics	Portfolio (%)	Benchmark (%)
12m Fwd P/E ratio	23.5	14.1
P/B ratio	4.3	1.9
Est dividend yield (%)	1.1	2
ROE	14.3	11.6
Expected 5Y growth CAGR	22.0	21.2
No. of issuers	58.0	660
Active share	57.5

Source: JPMorgan

Data as of 30 September 2020

Backed by strong returns

In recent times, JPMorgan Funds - China A (acc) SGD has enjoyed very good performance against the relevant benchmarks, as consumer and tech-related stocks have exploded in China. Over the past 10 years or so (since 31 December 2009), the fund has returned investors 122% or an estimated annual compounded rate of 8.7% p.a. (as of 30 Sep 2020).

As seen from the charts below, the fund’s performance picked up in a massive way only in 2019, a period marked by a big shift in market participants’ preference for growth and quality stocks in which the fund was positioned for. Moving forward, we think it is likely that the fund will continue to benefit from the market’s preference for such companies.

We agree with the fund manager that technology, consumer and healthcare related companies will continue to be important investment themes for China’s equity market. Given China’s continued emphasis on transitioning its economy towards a consumption-led one (see brief commentary on China’s latest ‘dual circulation’ plan by The Straits Times), the market environment likely remains favourable for consumer related industries.

Chart 3: Fund’s indexed performance against benchmark

The market environment that the fund will generally outperform or underperform in, is detailed Chart 4 below. As a growth and quality oriented fund, the best periods for the fund will be during periods of steady economic expansion – with the economy expanding neither too hot nor cold. Too hot, the fund risks underperforming against the benchmark which has greater relative exposure to traditional cyclicals such as financials.

And too cold, the fund runs the risk of exposing itself to higher momentum to the downside, given that growth-oriented stocks tend to trade at more expensive premiums and thus more vulnerable to risk-off sentiment. The best environment for the fund is likely during a recovery phase right after a cyclical trough; an environment with lukewarm economic conditions, similar to what its economy is experiencing now.

Chart 4: Fund’s year-on-year excess returns from 2012 to 2020

Who is this fund suited for?

This fund will be best suited for investors with a medium to long term investment horizon of 3 to 5 years or more, in order to capture the growth opportunities associated with the fund manager’s focus and objective. Investors should also have a high risk appetite with the willingness to accept higher relative drawdowns from time to time.