16th February 2024
Bear with me.
I know your inbox will have been inundated with posts this week with titles on some variation of ‘The Year of the Dragon’ as Chinese markets are closed this week as the country celebrates their New Year. Or perhaps for many commiserates it. Those who have been invested in Chinese equities in recent years don’t have much to be joyous about.
In aggregate, it’s been a brutal equity market to have been exposed to. Over the past three years (12/02/2021 to 13/02/2024), the MSCI China index is down -54%. MSCI Hong Kong is down -27%, and MSCI Asia ex Japan is -23%. These are all in sterling terms.
Over that same time, we have had exposure to two Asian equity income funds. “Uh oh, don’t run the performance charts!” I hear you shout.
But don’t fear. CIM Dividend Income is up +22% and Prusik Asian Equity Income is up +16%. Active management is well and truly alive. These fund managers are breathing fire. On average, both have had exposure of around 40% to Chinese/Hong Kong listed stocks and have averaged low exposure to the expensive Indian equity markets during the past three years which has performed very well (+48%). A double whammy of a headwind to performance.
We have long been acutely aware of the need for highly skilled and plugged in active managers if you are going to try to exploit the opportunities that the equity market offers in China. Perhaps more than any other market in the world, active managers must have a detailed knowledge of the political backdrop, the five-year plans of the CCP, and most importantly the areas of the market they are targeting support at and the areas that they want to make an example of.
Chinese stocks are close to all time trough valuations today – on a par with the Asian Financial Crisis in the late 1990s. CIM dividend Income’s portfolio has a dividend yield higher than the P/E ratio. In most markets, you might find a few stocks where that is the case – and you would probably be expecting an imminent dividend cut! Not so for these portfolios – despite this anomalous characteristic, dividends, supported by progression in earnings, are growing.
This is not just a China story in Asia, though. Right across Asia there are good quality companies paying out yields higher than their P/E ratio. We backed the launch of a new fund – Pacific North of South EM Income Opportunities, in 2022. The fund has less than 20% exposure to China/Hong Kong and yet has built a portfolio offering a forward dividend yield of 8.1% and a forward P/E of 7.1x. The very long term returns of the best performing equity market in the world – the US – average about 7-8% nominal per annum. We’re getting paid that in dividends from this portfolio – not a bad foundation for returns. Since launch in June 2022, the fund is up over 20%, compared with MSCI AC Asia ex Japan -6%.
When you add in that the US market is trading at or around its most expensive levels in all of history, meaning its future return prospects are close to the lowest in history, you can start to understand why we have a preference to look elsewhere for our equity exposure.
In Chinese culture, among other things the dragon symbolises success. Chinese authorities will be hoping that the next 12 months are more successful than the past 36 for the equity market – recently Chinese Premier Li Qiang said during a state council meeting that the country would be rolling out measures to stabilize its stock markets. We don’t pretend to know whether these steps will be successful in the short term but do think prevailing valuations provide an abundant margin of safety and, for experienced active managers, the foundation for exciting long-term returns.
Dan Cartridge – Fund Manager
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