China Q4 investment update

As with any investment, your capital is at risk. Past performance is not a guide to future returns.

Qian Zhang (QZ): Hello, everybody, and thanks for joining. My name is Qian Zhang. I'm an investment specialist for [the] China Strategy, and I'm joined by Linda Lin, head of our China Investment Team. Linda is currently working from our Shanghai office, and we are recording this at the beginning of January. So happy New Year and thank you for your support for our China Strategy over the past year.

We have quite a lot to cover today. We'll first review the market developments in the past quarter and year, and the potential implications from US election result and Chinese stimulus package. We will also discuss changes we've made to the portfolio and the rationales behind them. We will touch upon performance and our outlook for 2025 in the end.

So Linda, can you first start with the market backdrop, please?

Linda Lin (LL): Sure. After three years of decline, the Chinese market finally delivered a positive return in 2024. A part of this may have been driven by retail investors in China who speculate on the size of Beijing's stimulus package.

But when looking through the short-term noises, we believe the coordinated policy announcements since November has marked a significant pivot from the top. It's a very comprehensive plan of mortuary, physical, and regulatory policies. As we mentioned in the last quarterly video, I think this suggests that growth is finally back on [the] table, which can be a very important inflection point.

QZ: Thank you. Can you elaborate on how exactly these policies may work?

LL: I think the policy aims at two things. Firstly, refinancing the local government debt. Secondly, they need to [fix] the problem of the excess property inventory. These are the two largest risks to [the] Chinese economy, which hurt both the consumer demand and local government spending. Therefore, I think they're the right pinpoints to address.

So how does it work? While the policy measures are not structured to deliver a direct near-term boost on the demand, they [can] actually shape the demand trajectory by allowing the property market to recover and therefore restoring the consumer's confidence.

The logic is as follows. So when the property prices stabilize, the private sector businesses can invest more, then the investment and personal income can be improved. And the household can be more confident to spend more, not like what they're doing now, [i.e.] putting everything into their saving accounts. I think this is the same logic for the local government spending.

I have to say it's too early to tell if those policy shifts can materially rebuild the consumer's confidence, but we believe the direction of travel is right, and if anything, the recovery is likely to be gradual. I'm not expecting a V-shaped rebound, both in the property sector and also the consumer sentiment restoring.

QZ: Well, obviously a big variable here is President-elect Trump and the impacts potentially on trade and geopolitics. What's your and the team's take on this?

LL: That's a very good question. I think everyone, including President-elect himself, agrees that he's very unpredictable. So therefore, I think any current predictions should be held light-hearted. I think tariffs firstly are not good news, but the final impact will depend on many things.

Firstly, will Beijing be willing to devalue [its] RMB to absorb some of the shock? And secondly, do the Chinese exporters have some buffer? Because as you know, in the past few years, they have been trying to reshuffle the productions to the third countries.

And lastly, how much price elasticity US consumers have. I think Trump also likes deals, and he wants to win the deals. So, it's likely that US and China geopolitics becomes slightly more positive than many people think. And I'm sure you read the news, his recent reaction to TikTok. I think that's the first very important thing to watch in January 2025.

QZ: Thank you for that. Let's move on to the portfolio itself. How is it positioned and any changes you've made?

LL: I think we’ve become more confident that the domestic economy is seeing more policy support, while the outlook for exports and trades remains uncertain as we talk a lot about the tariff. So we did some adjustments in the portfolio accordingly.

So, over the last year, we have been reducing exposure to the companies with large revenue from the US, while adding to companies who will benefit from the Chinese domestic consumer recovery.

I think in most recent quarters, we made reductions in a few positions in our portfolio, including Anker, which is a number one 3C brand on Amazon, as well as Zhejiang Sanhua, which is a key supplier to the Tesla for the heating solution.

I think both of the businesses are very exciting in the long run, but we [think] the geopolitical risk in the short term [will] probably lower the scale of their potential upsides. So we decided to take some profit when both of the share prices had a very strong run in the last few quarters.

On the other hand, we added to the e-commerce player PDD. We think this is perhaps the best play of consumer recovery in China. We did a due diligence project for this company recently, where we tried to evaluate the health of PDD's ecosystem, including the merchant, consumer, and regulator.

The result generally was encouraging and convincing so we decided to add to the company when the share price [was] weak, even though the operational result actually [was] very strong.

QZ: In the last quarterly update, I remember you also mentioned the research that Shanghai team has been doing on semiconductor supply chains. I know that has been a focus of the portfolio and recent research pipelines as well. Any interesting findings?

LL: Yes, actually, we bought three semiconductor equipment companies listed in [the] Asia market in [the] last quarter, including AMEC, NAURA and Zhongji Innolight. This is in addition to our existing portfolio in the analogue chips designer space.

China has a very strong state-led model on investment in key industries. We mentioned a lot about EV and the perception of that was: it's probably sometimes not efficient and also sometimes it damages innovation. However, the process in [the] semiconductor industry has accelerated significantly since US sanctions.

So the sanction actually made the Chinese government more decisive to be self-sufficient and force a new collaborative model among the large sophisticated consumers and equipment players. And this is actually going to be a new model. And Huawei, as you know, is now using domestically made seven-nanometre chips in their smartphone.

So despite the challenge, localisation for us is a certain trend in the long term. Saying that, we reckon the growth of the semiconductor industry certainly is not coming [in] a straight line and could not be a smooth journey. The revenue can be quite bumpy given the long cycle of R&D and also the large orders.

Zhongji Innolight, for example, has been a detractor this quarter, but we expect this company will benefit significantly in the long run. So we're happy to hold this company through the volatility of the market.

QZ: Well, thank you. That's quite clear in terms of the changes and the rationale behind them in the portfolio. Let's move to performance. Any notable contributors or detractors to performance that you would like to highlight?

LL: Overall, the portfolio has slightly underperformed last quarter. As you know, we [are] always focusing on the long-term and don't want to time the market or react too much on the short-term price fluctuations.

However, we do have a process in place where we view the significant share price movement and associate with a valuation change. So one of the largest contributors this quarter was Shenzhen Megmeet. This is a company that makes power supply and electric automation products.

You may recall one of the key things in our portfolio is the industry automation and the green transition in China. And Megmeet is one of the best positioned companies benefitting from both of those structure trends. The company has recently been selected as a supplier to NVIDIA. So, the share price actually nearly doubled during the last quarter.

I think while this news is quite encouraging and [proves] Megmeet’s advantage and capability [over] global peers, we still believe the share price reaction has overshot the likely operational impact, at least in the next few quarters. So we decided to take the opportunity to take some profit from this position and add to other positions as I talked about before, like PDD.

QZ: Okay, so how about the detractor side in addition to the semi-names you just mentioned?

LL: Sure, I think on the detractor side, not owning Xiaomi has caused the performance. Xiaomi is a very famous 3C consumer brand in China and its primary revenue driver is still in smartphones. [The] share price has gone up, reflecting its success potential in the EV space.

We did the research this company and decided [to] pass on the valuation consideration. Also, we don't think it's adding more diversity into our portfolio. As you know, we own the largest EV brand in China, BYD, and also our portfolio has enough exposure to EV-related names, like CATL, and also like Megmeet, I just mentioned.

QZ: All right, thank you. Any final thoughts to share in terms of the outlook for 2025 for the asset class?

LL: Sure, I think we’re entering a very important year with [a] more positive outlook in general, and we remain confident in the quality of the growth drivers presented in our portfolio. So the biggest question is the effectiveness of the stimulus package overall on the economy. And that has to be proved in the next few quarters.

And also the uncertainty remains on Trump, like the tariffs and also what other policies he will bring to China. However, our on-the-ground research, as well as the conversations with different founders in different industries gives us a very clear conclusion, which is that Chinese companies are becoming increasingly competitive on [a] global scale.

So we're still in the transition period. I think that people think in China [is] still a producer of cheap, low-quality goods, but it’s becoming the leader of a number of global critical areas. I can point many examples from our portfolio, from the white goods producer Midea, to the EV battery maker CATL, and also to the world's largest EV maker [BYD].

So, in general, we think the valuations are still attractive, whether you compare China to developed markets or the rest of the emerging markets. This is at a time when domestic policy is improving into an inflection point and operational results of our portfolio companies continue to impress. So generally, I'm more positive for 2025.

QZ: Thank you. That's a very good point to end. Thanks for joining us. We wish you a great start of the year and see you next quarter.

Annual past performance to 31 December each year (net%)

Annualised returns to 31 December 2024 (net%)

*(MSCI All China prior to 27/11/19, MSCI Golden Dragon Prior to 02/05/19)
Source: Revolution, MSCI. US dollars. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised.

Past performance is not a guide to future returns.

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