Global investors have continued to sell off China equity funds and exchange-traded funds (ETFs), recording another $7 billion (£5.6 billion) of net outflows for the third quarter of 2023.
The sentiment continues to drag on the performance of Chinese equities. After months of sell-offs, Morningstar thinks the asset class could be a contrarian opportunity.
Bryan Cheung, associate director for manager research at Morningstar says: "expectations are low with sustained selling pressure, but the valuations are attractive. The forward price-to-earnings ratio of China equities are among the lowest versus the major EM countries, implying a better return potential in the longer term."
Cheung now thinks investor confidence will take some time to restore. "It’s always difficult to time the market's inflection point. We think investors should try to prepare rather than predict broad market movements," he says.
Despite outflows, there are highly-rated funds that stick to their investment disciplines. Three of these we highlight today are Schroder ISF China Opportunities, FSSA China Growth Fund, and T. Rowe Price China Evolution Equity Fund. All are Gold-rated, with a superior, time-tested investment process for the medium to long term.
Schroder ISF China Opportunities
Investors pulled a total of $168.38 million from Schroder ISF China Opportunities, whose outflows in October alone amounted to $7.55 million. Year to date, the fund slid 10.5%, compared to the China equity category’s 11.7% fall. Both the fund and the category underperformed the index's 5.8% decline.
Claire Liang, senior manager research analyst at Morningstar, thinks highly of the fund's experienced and savvy portfolio manager, sizable supporting cast, and proven investment process. These qualities have underpinned its Gold rating for its cheapest share class. Schroder ISF China Opportunities is one of the best China equity propositions across Morningstar's coverage.
According to Liang, the Schroders fund's investment process focuses on quality growth, led by deputy head of Asia ex-Japan equities Louisa Lo and the team of 17 greater China analysts. Liang thinks the investment process benefits from a robust and clearly defined framework, where analysts assess a company's growth prospects by comparing its return on invested capital and weighted average cost of capital. This earns the strategy a High rating in the Process pillar.
"Lo is pragmatic with her idea implementation and pays attention to companies' valuations," says Liang.
"While such an approach results in a higher portfolio turnover, which typically sits at the higher end of the 50%-100% range, over the past three years, Liang has seen Lo apply her valuation discipline and extensive industry experience to good effect.
"This includes her pre-emptive move on taking profit on some overheated information technology names in early 2022 prior to the sector’s downswing, which has helped the strategy navigate this year’s down market."
In the portfolio, Alibaba Group (09988) and Tencent Holdings (00700) each took close of a 10% weight. Meituan (03690) came in as the third largest holding with a 4.84% weight.
FSSA China Growth Fund
Gold-rated FSSA China Growth Fund faced outflows of $19.72 million for October. So far this year, outflows of $32.6 million were recorded in the $2.5 billion fund. The class I for the fund returned negatively over the short term, down 14.5% year to date. This underperforms the category's 11.7% and the index's 5.8%.
Morningstar analysts think the strategy benefits from a top-notch portfolio manager and a tight-knit and experienced investment team. The team continues to sport a strong investment culture, one that aligns its interest with investors and is mindful of succession planning. Analysts assign a High rating for the People pillar.
Another strength of this strategy is its well-structured and thorough bottom-up research process, which has delivered impressive track records across all of Lau's Asian and Greater China equity mandates over the long haul. Earning the highest rating in the Process pillar, the process seeks to identify high-quality companies that deliver sustainable and predictable growth at reasonable valuations. Management quality is of the utmost importance: the team prefers management teams that act with integrity, have high governance standards, have a demonstrable track record of allocating capital effectively, and are well-aligned with minority shareholders.
The largest position in the fund is Tencent Holdings (00700), representing 7.3% of the portfolio Home appliance maker Midea Group (000333) took 5.8% weight and 4.85% of capital is invested in China Merchants Bank (03968).
T. Rowe Price China Evolution Equity Fund
T. Rowe Price China Evolution Equity Fund experienced outflows of $2.8 million since the beginning of 2023. In October, the redemption totaled $2.0 million. As of the end of October, the fund has $96 million under management. The class Q for the fund fell 12.4% year to date. This underperforms the category's 11.7% and the index’s 5.8%. Scoring the highest in all three pillars, the fund earns a Gold rating.
Confidence of our analysts in the strategy's portfolio management drives a High People Pillar rating. The strategy's sensible investment philosophy earns a High Process Pillar rating. This strategy skews toward smaller, higher-growth companies compared with its average peer in the category. Our analysts believe this strategy has consistently had a defensive tilt owing to its exposure to high-quality stocks over the past few years. Though it may trail peers during an economic boom, this orientation contributes to helping it weather periods of economic stress better.
At the end of October, the fund's largest bet was in online recruitment platform Kanzhun Ltd, representing 7.6% of total assets. Other top holdings include mall operator CR Mixc Lifestyle Service (01209), Yangzijiang Shipbuilding (BS6), and hotel manager H World (01179).
