Every fund in the Investment Association’s China/Greater China, Asia Pacific ex Japan and IA Global Emerging Markets sectors bar one has made a loss over the past month, leaving investors worried about how the China sell-off will affect their portfolios.
While the Greek debt crisis has dominated headlines and markets over recent weeks, the sustained sell-off in China could be a bigger problem for investors to deal with – and is already causing some funds to post heavy losses.
Over the past month, the MSCI World has fallen by 3.03 per cent while the FTSE All Share is down 4.97 per cent. Greece’s negotiations with its creditors and the country’s vote to refuse extra austerity measures for further support has been the headline cause of these falls.
However, FOREX.com research director Kathleen Brooks said: “This is not all down to Greece, but volatility in Chinese stocks, which have seen huge price swings in recent days. If the Chinese authorities can’t get the Shanghai Composite index under control then risk sentiment could suffer across the Asia region and further afield.”
The Shanghai Composite, which has been surging for most of the past year, has fallen by more than 25 per cent over the past month. The country’s securities regulator has warned that “panic sentiment” is gripping investors.
Performance of indices over 1yr
Source: FE Analytics
The Chinese authorities have implemented a series of measures to limit the market’s freefall over recent days including suspending new share offerings, ordering brokerages to buy shares and promising to provide liquidity, while around 1,300 firms – almost half of China's main shares – have halted trading.
Beijing is keen to show it can control the slide to reassure of its ability to liberalise the market and reform the economy, plus it does not want a market correction to have a knock-on effect on the real economy. Another point is that most shares have been bought by small retail investors not institutional investors and the authorities do not want to risk the sell-off prompting social unrest.
So far Beijing’s measures have failed to restore confidence in the market and, although it is still up around 100 per cent over the past year, some analysts expect the pain to continue.
The strong run in Chinese stocks – Hong Kong’s Hang Seng also rose over the past year, although nowhere near to the extent of the Shanghai Composite and its recent falls have been correspondingly smaller – means that China, Asia and emerging market equity funds have posted strong returns over the past year.
However, FE Analytics shows that every fund in the IA China/Greater China and IA Asia Pacific ex Japan sector has made a loss over the past month while every IA Global Emerging Markets portfolio apart from F&C Emerging Markets (which is up 0.2 per cent) is also down.
Performance of sectors over 1 month
Source: FE Analytics
The IA China/Greater China member that has made the biggest loss over the past month is New Capital China Equity, which is headed up by FE Alpha Manager Mansfield Mok. The fund is also down on three and six-month views but a 27.28 per cent return makes it the peer group’s best performer over one year.
In his latest update published in June, Mok warned about near-term turbulence in Chinese stocks but argued that there are reasons to be positive over the long run. “Looking ahead, we expect the market to remain volatile in the short-term given the large accumulated profit from early investors,” he said.
“However, given the global fund’s underweight position in China, we expect China’s equity market to see increasing inflow supported by reforms and reasonable valuation. China’s current easy monetary policy could also help to facilitate structural reform.”
As the below graph shows, the other China funds being hit hardest in the sell-off are Baring China Select, Matthews Asia China Dividend, Matthews Asia China Small Companies and GAM Star China Equity.
Performance of funds vs sector over 1 month
Source: FE Analytics
GAM Star Asian Equity is the fund from the IA Asia Pacific ex Japan sector has seen the biggest monthly loss after falling 13.60 per cent. The fund, which has 45 per cent of assets in China, is also lagging over its average peer over three and five-year views.
CF Canlife Asia Pacific has 49.1 per cent in Hong Kong and China, leading to a 11.93 per cent loss; Cavendish Asia Pacific is down 9.69 per cent and has 25.6 per cent in China with another 19.7 per cent in Hong Kong; and Hermes Asia ex Japan Equity has fallen 9.38 per cent thanks to its 42.92 per cent China weighting and 5 per cent Hong Kong allocation.
Performance of funds vs sector over 1 month
Source: FE Analytics
When it comes to the IA Global Emerging Markets sector, NFU Mutual Global Emerging Markets has made the biggest one-month loss of 8.07 per cent. The fund does not publish regional allocation breakdowns but its top-10 includes the likes of mainland China-focused travel agency Ctrip, China Railway Group, Chinese multinational consumer electronics and home appliances firm Haier and Industrial and Commercial Bank of China.
Capital International Emerging Markets, which has Macau casino operator Melco Crown Entertainment and China Mengniu Dairy as major holdings, has lost 7.85 per cent; GAM Star North of South EM Equity has 20.25 per cent in China and 3 per in Hong Kong, leading to a 7.51 per cent fall; while Neptune Emerging Markets is down 7.40 per cent and has 39.1 per cent in China/Hong Kong.
Of course, one month of returns is too short a time frame to base investment decisions on. But the outlook for Chinese equities does not seem overly positive in the short term, given the market’s negative reaction to the government’s intervention.
The Shanghai Composite rose by close to 180 per cent between 7 July 2014 and 7 June 2015, after the Chinese government made it easier for Hong Kong-based investors to buy mainland stocks and vice versa. The authorities also encouraged retail investors to play the market.
Mark Williams, chief Asia economist at Capital Economics, said: “The equity bubble was not the result of a hands-off approach by policymakers. It began to inflate last summer on the back of a series of high profile articles in state-run media urging investors to enter the market. Policymakers and state media continued to trumpet the rally even as prices rose well beyond most reasonable estimates of fair valuation.”
“In our view, the best explanation for the leadership’s full-bore response to the market fall is that it feels that its own credibility is at risk. The common perception since last summer has been that the government wanted a sustained rally and would act to keep it going. Official media was trumpeting the markets’ rise and even suggested that scepticism about it reflected a lack of confidence in the leadership’s plans for economic reform.”
“We suspect that, having encouraged that narrative to take hold, the leadership now feels that the market fall casts doubt on its competence. It is following a risky path. Our view remains that a market rally cannot run ahead of economic fundamentals indefinitely. With the average trailing P/E ratio in Shanghai now at 18, which is towards the upper end of typical valuations in fast-growing EMs, there is a good chance that the market rescue efforts are seen to be a failure in a few months’ time.”
