As China enters the Year of the Tiger, we look back on a tough 2021. The long-term uptrend of large consumer companies like Alibaba and Tencent ended abruptly as the state prioritised objectives like social stability and common prosperity. Internal political winds amplified a wave of regulations which impacted sectors from education and e-commerce to Macau gaming. New measures sharply changed the growth prospects of these sectors, resulting in significant share price corrections. Further volatility came as policies to curb property speculation eventually brought down heavily-indebted Evergrande, a large developer. This all led to widespread negative sentiment among foreign investors. Offshore listed companies in Hong Kong and the US fell indiscriminately.
By contrast, onshore China A shares delivered better returns with many sectors doing well, especially those that are linked to the green economy or the inward replacement of supply chains.
Rough times for many Chinese fund managers
For Chinese fund managers, 2021 was challenging. The offshore-dominated MSCI China All Shares index returned -12.8% with the median of 112 Greater China / All China products underperforming by a further 0.6%. For onshore-focused China A share managers, a peer group of 54 products delivered +0.3% versus the MSCI China A Onshore index return of +4.2%. Normally we expect a majority of managers to outperform which wasn’t the case in 2021. The year also saw an unusually high dispersion of returns (the range between best and worst).
A few managers delivered good results but overall, diversification was key. Examples of outperforming managers were those who drastically rebalanced portfolios away from consumer and technology early on or who had historically avoided those areas on valuation grounds.
Let’s look at how different groups of managers performed in 2021.
Buy and hold managers of Consumer stocks
This cohort was in for a shock. Many had delivered incredible returns over the previous 3-5 years when large consumer brands such as Tencent, Alibaba and Moutai grew significantly as domestic consumption increased and the state incentivised the digital economy. These large blue-chip holdings also benefitted from positive sentiment among global and local investors. It all changed in 2021.
Many managers based their strategy on “patient investing in the best companies”. Warren Buffett would approve but the approach only works if the thesis is correct and the environment is largely predictable. In China the market is less efficient and company fundamentals can change over short periods. Last year was a perfect example. Many managers missed the intensifying competition in e-commerce and that many well-known brands were profiteering from monopolistic practices where the government’s patience was running out. Business models were simply not sustainable.
Nimble growth managers
Experienced Chinese equity investors have realised that this market has some major differences to developed markets:
- It is less efficient: share prices can significantly depart from fundamentals and reach extreme valuations
- Competition, regulation and consumer habits are fast-changing and can dramatically impact the fundamentals of even the market leaders
- The investment opportunity set is vast so there are always opportunities to upgrade the portfolio
Nimble growth managers also consider themselves long-term investors but increase and reduce their holdings in a company over time depending on prevailing conditions, risk factors and valuation. A manager might have allocations to Tencent and Moutai ranging between 0% to 20% over the last three years and added significant value by doing this.
Most in this group also had large allocations to consumer companies at the beginning of 2021 but some felt the high valuations were unjustified and successfully rotated into other sectors. Those that didn’t, suffered. The best performers correctly identified the potential demand for products and services required to transition to a greener economy and built sizable positions in the green supply chain.
Bouyed by a general rotation into value stocks, many who focus on this area outperformed in 2021. These managers had previously avoided (to their cost) the hyped sectors, but benefited when these derated and additionally had little exposure to those sectors impacted by regulation. Still, it was not an easy year for them. Exposure to “cheap” financials and property stocks did not perform amidst an economic slowdown and then there was the Evergrande crisis.
No value manager can resist a bargain — but what is really a “bargain”? As prices of companies like Alibaba have their tremendous fall from glory, the danger is to re-enter far too early and have no powder left when prices eventually do bottom out.
Some of 2021’s best performing fund managers were those with a pragmatic investment style: look for good growth companies but be very sensitive to valuation. They generally don’t participate in any hype/theme, had a tough year in 2020 (missing the growth rally) and didn’t have a lot of exposure to the trendy themes of 2021 (like electric cars). However, steady annual returns over time can result in attractive overall results – something we aim for ourselves when advising funds.
Last year was a tough year for many fund managers in China. Diversification across multiple styles allows investors to capture gains where they were available and to outperform the benchmark. A point that we make repeatedly is that a successful fund managers must understand how investing in China has its nuances and is a fast-changing enviroment that must be appreciated in order to succeed.
RisCura wishes you and your family a healthy and prosperous Year of the Tiger.
This article first appeared in Pension Funds Online.
– Lars Hagenbuch