Deep Dive: Endowus China Equities Portfolio
Endowus Insights

Deep Dive: Endowus China Equities Portfolio

Updated
April 29, 2022
published
November 24, 2021
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  • Capture China's high growth potential.

China has seen rapid growth, undergone significant structural reforms and has become the world's second largest equity market with return opportunities across various new and traditional sectors.

  • Best of both worlds: onshore and offshore equities

Broad and diverse exposure to China's structural growth opportunities through onshore such as A-shares, and offshore greater China exposures through various market listings in HK, US, Taiwan and other markets.

  • Managed by leading China market specialists

Navigate China's markets in a multi-manager portfolio through leading experts who have invested in China for decades, such as JP Morgan, Schroders, FSSA, Allianz and Aberdeen.

What is the Endowus China Equities Portfolio?

The Endowus China Equities Portfolio(“Portfolio”) focuses on efficiently capturing the best opportunities in both onshore and offshore Chinese equity investing. Consisting of five best-in-class funds that have consistently outperformed the market, this portfolio is for investors who seek significant alpha opportunities and are looking to invest for the long term in a diversified and efficient portfolio.

The Portfolio is designed to give access to the opportunities in China and the Greater China universe, including markets such as Hong Kong, Taiwan, and Macau. For this purpose, the Portfolio will tap into the various types of Chinese equities, such as:

  • Onshore China equities: Chinese companies listed within mainland China (Shanghai and Shenzhen), also known as China A-Shares or B-shares;
  • Offshore China equities: Chinese companies listed on stock exchanges outside of China, such as in Hong Kong (H-Shares), or even the US (ADRs) or other offshore markets where Chinese companies are listed;
  • Greater China equities: companies from Hong Kong, Taiwan, and Macau listed in their respective stock exchanges; and
  • Other equities: companies from countries with no cultural ties with China, but are listed in stock exchanges within Greater China, or companies that have a significant business dependency to China.

Learn more about how you should approach a Core-Satellite Portfolio investment strategy here.

China Equity Portfolio - Country allocation
China Equity Portfolio - Sector allocation

The Portfolio has a robust exposure to the related regions, with a heavy allocation to Chinese companies to reflect the large opportunity set in the market. It also has a notable exposure to Hong Kong and Taiwanese companies. Investments into companies from other countries are more opportunistic, and as of 31 October 2021, the Portfolio allocates about 1.5% of its assets to equities from the UK, US, Italy, and Australia, taking into consideration the close business relationships of the companies with China.

Sector allocation is highly diversified, with a healthy balance to both “new economy” industries such as consumer discretionary, healthcare, and technology, as well as “old economy” industries like consumer staples, industrials, and real estate.

What are the underlying funds in the Endowus China Equities Portfolio?

China Equity Portfolio - underlying funds

We have selected five best-in-class funds focused on investing in China and related regions and companies, managed by globally-renowned fund houses who are experts in investing in China and Greater China markets including Abrdn (formerly known as Aberdeen Standard), Allianz, First Sentier FSSA, JP Morgan Asset Management, and Schroders. The funds were chosen for their strong, market-beating performances that place them among the top percentiles among their peers, as well as for their unique investment focus as summarised above. Collectively, the funds provide investors an optimised exposure to investing in China.

Why invest in China Equities?

China’s market outlook remains strong despite regulatory risks

Growth of MSCI golden dragon

China has rapidly emerged through unprecedented growth and thereby transformed itself into the second largest economy in the world in a short span of time. Despite this, there have been looming concerns on the sustainability of China’s high growth rates and concerns about structural issues that have been paved over and will come back to haunt them. The huge indebtedness of and debt-fueled growth is a major concern especially in certain sectors of the economy including real estate and manufacturing. These concerns have been exacerbated by the regulatory risk and systematic risk of being a control economy. With the recent regulatory crackdown casting major doubt about some of the most prominent companies in the Chinese equity market. However, not all sectors are heavily and negatively impacted by the crackdown, and investors should consider a more diverse universe outside of just high-profile names and shows why diversification is so critical even within a China market universe.

Different impacts of regulatory crackdown

Additionally, given that such anti-monopolistic market intervention is rather common and well-received by both large and small players in sophisticated economies like the US and Europe, a more prudent investor might view regulatory risks as a necessary growing pain as the Chinese economy matures. Obviously, regulatory risk is not something new to the Chinese market — recall events such as the US-China tensions in 2018, and the market crash in 2015 that followed after the opening up of the Onshore stock market. Despite such headwinds, the market has demonstrated some resilience through these unique challenges and in the end as a growth asset class, equities returns will be determined by the earnings growth of the listed entities in the stock market.

China offers a large & diverse investment universe

About Chinese equities

In that regard, despite the complicated structure of multiple stock exchanges and multiple listings of certain companies, this provides a broad opportunity set from which to invest and generate investment returns. The Chinese equity markets have both the Onshore exchanges (e.g. Shanghai and Shenzhen Stock Exchanges) as well as Offshore markets (e.g. Hong Kong) and we have invested in funds that have investments in a broader mandate of companies with high China exposure as well. This exposure to not only the second largest equity market in the world, but also more broadly companies that leverage the second largest economy and consumers carry rather distinct opportunities that are diversified.

Chinese equities are lowly correlated to major global equities

Another characteristic that makes Chinese equities unique is the fact that its economy is heavily driven by domestic factors. Companies on the Onshore Chinese market derive, on average, 90% of their revenue locally, which reduces the economy’s dependence on global macroeconomic trends. Companies in the region, such as Hong Kong and Taiwan, are similarly reliant on mainland Chinese revenue rather than from the rest of the world. This is really important when we look at China equities in comparison to other major markets in the region and globally. It is interesting to note the very low correlation China markets have with other global markets. This is another attractive point for investors who want to add further diversification benefits or uncorrelated returns to their investment portfolio.

China offers significant alpha opportunities

Experienced investors would remember that the Onshore Chinese market used to be largely inaccessible to foreign capital. The Onshore markets opened up partially to foreign investors only in 2014 via the Stock Connect Programme, and prior to that, the Hong Kong stock exchange provided an alternative for foreign investors to gain exposure to the Chinese market.

Significant alpha oppotunities in China Onshore

It is exactly due to this “infancy” of the Onshore Chinese market, however, that it offers attractive alpha opportunities for savvy investors. As the market is new to the broader investor base and therefore under-analysed, it rewards investors who put in the effort to understand the companies in greater detail and allocate to those with sustainable long-term fundamentals.

Chinese equities are undervalued

Additionally, the Chinese equity market is currently trading at a valuation that is lower than other major global markets. While this is partially due to the regulatory and systemic risk and the fact that capital markets are not completely open to foreign investors, there are certain companies or sectors that naturally present opportunities for re-rating over time as the market continues to open up and the companies deliver higher growth.

Who should invest in China Equities?

Growth of wealth of MSCI Golden Dragon- a bumpy road

While Chinese equities offer highly attractive opportunities as outlined above, the market is not without its risks; in fact, the market is a highly volatile market with high retail participation and low institutionalisation. Therefore, an investor should consider his risk appetite carefully before deciding to allocate specifically into China.

A quick and simple assessment of one’s risk appetite investing in China, would be for an investor to ask himself, “if the Global Financial Crisis (“GFC”), US-China Trade War, or regulatory crackdowns were to happen again tomorrow, will I be able to stay invested despite the short-term losses?”. In the three market crises in 2007 (GFC), 2018 (US-China trade war), and 2021 (regulatory crackdown), the MSCI Golden Dragon Index, a broad index of Greater China large and mid cap stocks, suffered large drawdowns of approximately 60%, 13%, and 16% respectively. Although such events may have been rather unusual and infrequent, there is no guarantee that something of a similar nature will not occur again.

Additionally, apart from such major market crashes, the Chinese equity market has been historically volatile with an annualised volatility of 21% from May 2000 to October 2021. Given this, another relevant question would be “how long can I stay invested with the losses, if there was even a small dip in the Chinese equity market tomorrow?”. Ultimately, the longer one’s investment horizon, the greater the chance of the investment riding out the market volatility to achieve a higher return.

All in all, investors who are prepared to withstand the potentially steep losses arising from market volatility and have a mid-to-long term investment horizon would be best suited to allocate to Chinese equities.

Why should you invest in the Endowus China Equities Portfolio?

Invest in a diversified & efficient portfolio

Obviously a country portfolio has limited ability to diversify, but the China market is unique in that it has several stock exchanges in different jurisdictions with a diverse range of sectors being represented in these various exchanges. The overall diversification of the Portfolio is also achieved through a purposeful determination in the portfolio creation to make it a Greater China portfolio where the opportunities to invest in both onshore and offshore markets allows a slightly broader investment opportunity through diversification to other geographies like HK, Taiwan and Macau, and also through various currency diversification in HKD, TWD, USD, etc. This is especially true when assessing the Portfolio from a sectoral point of view (as previously shown), as well based on the place of listing.

Additionally, the Portfolio will tactically allocate into the Onshore or Offshore versions of the underlying equities when considering Chinese companies that are dual-listed — this is efficient because there are occasions when the Onshore versions trade at a higher price, due to the immaturity of the Onshore market that attracts high participation from retail investors and there are arbitrage opportunities.

Active management by top fund managers to generate higher returns with lower risk

Given the vast investment universe for Chinese equities, as well as the complexity in obtaining local, ground-level knowledge that impacts the day-to-day operations of the companies, we think that Chinese equities investing can be most efficiently done by leveraging the expertise of expert fund managers to extract alpha through their unique investment approaches. This is also especially true when looking at Onshore Chinese equities, as the market is less mature and provides attractive alpha opportunities.

The Portfolio has been constructed to benefit from the collective wisdom of the underlying funds to generate the best possible risk-adjusted returns through exposure to a diverse basket of companies across Chinese equities, and this has proven to be successful historically compared to the market. China is unique in that there is no single market index that represents the broad market well. Due to the narrow scope of some of its various indexes it is even difficult to track what the overall Chinese market has done. We present the four major indexes that people use to track the China market overseas with the MSCI Golden Dragon being the broader measure including Taiwan, Hong Kong markets. Across the various indexes the Endowus China Equities portfolio has generated good returns adjusted for risk and represents the opportunity to expose yourself to the broader Greater China markets.

Endowus China Equity Portfolio outperformed main indices

Ongoing assessment of underlying funds by Endowus Investment Office

The underlying funds in the Portfolio have been selected based on the rigorous assessment by the Endowus Investment Office for their superior quantitative and qualitative characteristics, and are believed to be the best-in-class among their peers that are available to retail investors in Singapore today. However, with that said, we recognise that the China equity market is constantly evolving, giving rise to new ideas and funds that effectively capture them. To make sure that the Portfolio reflects the best opportunities in Chinese equities investing, we conduct ongoing re-assessments of the funds to ensure that their superior characteristics are maintained into the future, and where needed, to introduce new funds to supplement or replace the existing portfolio design.

Learn more about how you should approach a Core-Satellite Portfolio investment strategy here.

Appendix: Portfolio Details

Portfolio allocation and cost

Portfolio allocation of Endowus China Equity Portfolio

Historical risk and return

Historical risk and return of Endowus China Equity Portfolio

Detailed country breakdown and selected portfolio holdings

Breakdown of Endowus China Portfolio

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Investment involves risk. Past performance is not necessarily a guide to future performance or returns. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund.

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