Macro/Market Update by Lilian Co

FUND UPDATE/POSITIONING As at 9 July 2015, the Strategic China Panda Fund has exposure to the H share market and A and B share markets totalling 63.42% and 13.82% respectively. Large caps represent 56.57% of the portfolio, with weigthings in mid cap stocks at 19.45% and 14.45% expsore to small caps. The current raft of suspensions which has taken place on the A-share market has primarily been within the small and mid cap space, whereas the Fund’s A-share exposure is towards large cap stocks. As a result of the recent market trend towards suspension of stocks, the Fund has only 1 position (of at total of 42 positions) which has been impacted, Hangzhou Hikvision Digital-A (002415 CS) representing 0.09% of NAV. Net exposure will likely remain in the 80-90% range and Lilian may further trim long positions in the A share market to manage volatility. MACRO/MARKET UPDATE We think the negative wealth effect from the recent stock market correction on domestic consumption is limited. First, stock investment only represent 10% of household financial assets (versus 30% in developed economies like US). Second, the savings rate in China is high at over 40%. There is ample buffer even if individual investors lose money in the stock market. Third, retail sales growth YTD has not picked up despite robust stock market performance. Simply put, Chinese households have strong enough balance sheets to absorb losses and the period of a buoyant stock market is too short to create positive wealth effect to the real economy and hence there is limited negative downside from a wealth perspective to talk about now. We do not see the recent market correction posing systematic risk to the real economy either. We think the recent market rout is a liquidity crisis as a result of clumsy intervention from the regulator. Luckily, the PBOC has finally stepped in to provide unlimited credit facilities to the major securities firms. We see forced selling due to margin call (the culprit of the market plunge) can finally be put to a halt. Besides, only 4.2% of total social financing needs are raised from the equity market.

Monthly Fund Commentary
13 Jul 2015

FUND UPDATE/POSITIONING

  1. As at 9 July 2015, the Strategic China Panda Fund has exposure to the H share market and A and B share markets totalling 63.42% and 13.82% respectively.
  2. Large caps represent 56.57% of the portfolio, with weigthings in mid cap stocks at 19.45% and 14.45% expsore to small caps.
  3. The current raft of suspensions which has taken place on the A-share market has primarily been within the small and mid cap space, whereas the Fund’s A-share exposure is towards large cap stocks. As a result of the recent market trend towards suspension of stocks, the Fund has only 1 position (of at total of 42 positions) which has been impacted, Hangzhou Hikvision Digital-A (002415 CS) representing 0.09% of NAV.
  4. Net exposure will likely remain in the 80-90% range and Lilian may further trim long positions in the A share market to manage volatility.

MACRO/MARKET UPDATE

We think the negative wealth effect from the recent stock market correction on domestic consumption is limited. First, stock investment only represent 10% of household financial assets (versus 30% in developed economies like US). Second, the savings rate in China is high at over 40%. There is ample buffer even if individual investors lose money in the stock market. Third, retail sales growth YTD has not picked up despite robust stock market performance. Simply put, Chinese households have strong enough balance sheets to absorb losses and the period of a buoyant stock market is too short to create positive wealth effect to the real economy and hence there is limited negative downside from a wealth perspective to talk about now. We do not see the recent market correction posing systematic risk to the real economy either. We think the recent market rout is a liquidity crisis as a result of clumsy intervention from the regulator. Luckily, the PBOC has finally stepped in to provide unlimited credit facilities to the major securities firms. We see forced selling due to margin call (the culprit of the market plunge) can finally be put to a halt. Besides, only 4.2% of total social financing needs are raised from the equity market.

We do not see corporates running into working capital problems even if the fund raising function of the capital market is shut down temporarily. After all, market cap/GDP in China is only around 70%. This is not particularly high compared to developed countries at close to or above 100. Lastly, a large part of the margin financing deleveraging has been undertaken after the sharp market correction. Margin financing balance has been shrinking fast since the peak of Rmb2.4 trillion in mid June to now $1.5trillion. This is back to the March levels which is the point at which the stock market started rallying. In short, we have seen the worst of the deleveraging and expect the market to stabilize very soon.

We did not adjust risk significantly in the last few days because of the irrational market and we felt the best strategy was to review the investment case only when the market stabilizes. Now that the market is rebounding, we will review net and gross exposure. We do not think the China story is over but this is one of those liquidity crunchs we see in China every now and then. This happened in 2011 (LGFV debt concern) and 2013 (interbank rate spike in mid year due to liquidity withdrawal by the central bank) before but the liquidity crisis was always resolved as soon as the government stepped in. The MSCI China P/E is now cheap at about 10x post recent correction. Patient investors will be rewarded eventually.

The views and statements contained herein are those of LBN Advisers Limited in their capacity as Investment Adviser to the Fund as of 10/07/15 and are based on internal research and modelling.