e-fundresearch.com: Which personal cognitions did you draw from the market developments in 2017?Fabrice Jacob: In 2017 Chinese markets were driven by flows as well as by good macro indicators. We have all reasons to believe it will carry on next year. The stability of the RMB achieved through the closing of the capital account has seen mainland Chinese institutional money positioning itself aggressively on the Hong Kong stock market that trades at a 23% discount to the A share market. Flows coming to Hong Kong from mainland China are now twice as much as what they were at the start of the year whereas overseas flows going into the A share market of China using the Stock Connect platform have trebled over the same period. The inclusion of A shares in MSCI indices in June next year will probably accelerate the process of integration of A shares in foreign institutional portfolios which remain by and large very little exposed to the second largest equity market in the world.
e-fundresearch.com: Are you more optimistic or pessimistic today than at the end of the year 2016, and why?Fabrice Jacob: We started 2016 being very confident in the impact the supply side reforms and the exchange control measures would have on the economy and the currency, allowing for a deleveraging to kick start. Not only did these predictions materialise, it turned out that China also benefited greatly from the economic rebound of Western economies. In 2018 we anticipate a gradual loosening of monetary policy in reaction to softening macro numbers. This softening is already well flagged to investors and is partly due to the strict implementation of Home Purchase Restrictions that hit the property sector and that led to a drastic fall in property inventory, especially in Tier 3 cities, all combined with a high base effect. As projects new starts are seen dropping, we anticipate the government to react by reversing its tightening policy, starting with a gradual relaxation of Home Purchase Restrictions in Tier 2 cities.
e-fundresearch.com: Performance of the fund in 2017: Which trends did you particularly benefit from? Where were the challenges?
Fabrice Jacob: Our China fund returned more than 50% this year, driven by the technology and pharmaceutical sectors, the consumer discretionary sector and the real estate sector. Our stock picks in A shares performed remarkably well despite the A share market having been a relative laggard compared with the exceptional performance of Chinese stocks traded offshore. Major themes we benefited from was the premiumisation of the consumer sector, the emergence of Chinese leaders within the automotive sector, the infrastructure build-up surrounding the future launch of 5G networks, the emergence of dual cameras and face recognition technologies in smartphones, the strong push of biological drugs and the ever-growing budgets dedicated by parents to the education of their only child. Challenges for us were seen with construction companies involved in Public Private Partnerships (PPP) where these companies participate in the equity ownership of the projects they build upon the request of local governments. The government has been blowing hot and cold air on PPP projects, pushing for them but at the same time restricting their access to credit. This theme has not played out in 2017.
e-fundresearch.com: Which trade or positioning do you particularly like to look back on?
Fabrice Jacob: Our trade in emerging camera module maker QTech played out well as we bought the shares around HK$4 at the end of 2016 and started trimming over the summer of 2017 after it had reached more than HK$18. This was a relatively uncovered small cap when we bought it. The company impressed us for being able to penetrate the Chinese smartphone supply chain with its dual camera modules, its fingerprint sensors and which is now actively developing 3D sensing and lenses for Huawei, Xiaomi, Vivo and Oppo, the four Chinese leaders that see their global footprint ever-expanding. QTech can be seen as a smaller Sunny Optical, a Chinese module maker that is arguably the best success story of the past five years within the China technology space. QTech remains relatively under-covered and is trading at a 42% discount to Sunny Optical despite a similar earnings growth anticipated for 2018.
e-fundresearch.com: Which consensus views are the main concerns for you in the current environment?
Fabrice Jacob: The technology sector remains particularly promising as China has repeatedly emphasised how digitalisation was the most favoured way to rebalance from a production driven economy to a service driven economy. There is no other country in the world where big data and artificial intelligence have so much government driven tailwind while avoiding the parliamentary pushback seen in western democracies when it comes to the protection of private data. The fact that Tencent and Alibaba are now among the ten largest companies in the world by market capitalisation is not a coincidence. What concerns us however is the aggressiveness of earnings forecasts put forward by sell-side analysts for these two companies and for all Chinese companies gravitating around artificial intelligence. We believe monetisation will not come as fast as anticipated, leading at some point to earnings downgrades. Given their position as bellwethers of the MSCI China index, earnings downgrades, let alone earnings misses at Tencent and Alibaba could have a spiralling impact due to their weighting in Chinese and emerging markets ETFs.
e-fundresearch.com: Looking into the future: What are the central themes for your asset class in 2018 and how do these events influence the positioning of your portfolio?
Fabrice Jacob: The premiumisation of the consumer sector is for everyone to see, be it in staple products such as milk and snacks or in discretionary goods such as automobiles or smartphones. Chinese consumers are becoming very savvy, better informed about brand equity value, about product safety, and more and more picky when it comes to selecting a product to buy. This is a long term theme that favours companies with high budgets for research and development even though margins may be lower than that of their less demanding competitors.
Another theme that arguably will play out for the coming years is the development of 5G that will allow data communication to be transmitted at a speed that will be 50 times faster than the current 4G (LTE) standard. This new technology that is expected to roll out in 2020 will be the catalyst for the real pickup of Internet of Things when objects such as cars start to communicate with each other. Benefiting from a strong governmental push, we anticipate equipment makers and optic fibre producers to enjoy golden years ahead of the formal launch.