Jpmorgan China Growth & Income Trust Plc
Unaudited Half Year Results For The Six Months
Ended 31st March 2022
Chairman's Statement
Performance
In his final Chairman's Statement published in December 2021, my predecessor John Misselbrook warned of the inherent risks in investing in China. This comment proved timely: the six months ended 31st March 2022 turned out to be a challenging period for the Chinese economy, its stock markets and our Company. Already shaken by unexpected regulatory changes, slowing economic growth, concerns about the domestic property sector and heightened US-China tensions, sentiment towards Chinese stock markets deteriorated sharply from January 2022, amidst reports of new COVID lockdowns and concerns about the broader impact of Russia's invasion of Ukraine. Over the six months ended 31st March 2022, therefore, our Company's total return on net assets (with net dividends reinvested) fell 30.8%, underperforming the benchmark MSCI China Index's 17.5% decline (in sterling terms). The total return to shareholders for this period also fell by 26.4%.
The relative underperformance to the benchmark index is explained in the Investment Managers' Report on page 9. This report provides a detailed commentary on the portfolio positioning and the outlook for investing in China.
Loan Facility and Gearing
The Investment Managers have been given the flexibility by the Board to manage gearing tactically within a range set by the Board of 10% net cash to 20% geared. During the period the Company's gearing ranged from 7.0% to 20.6%, ending the half year at 17.8%.
In July 2021, the Company renewed its £50 million loan facility (with an option to increase it to £60 million) with The Bank Nova Scotia for a further two years. In December 2021, the Board elected to use the accordion facility and thereby increased the loan to £60 million. As at 31st March 2022, £59.7 million of this facility was drawn down.
Our Dividend Policy
At the Annual General Meeting in February 2020, shareholders approved an amendment to the Company's Articles of Association to allow the Company to distribute capital as income to enable the implementation of the revised dividend policy.
Shareholders are reminded that the target annual dividend of 4% of the Company's NAV on the last business day of the preceding financial year is announced at the start of each financial year, to provide clarity to shareholders over the income stream they can expect during the following 12 months. This is paid by way of four equal interim dividends on the first business day in March, June, September, and December.
On 1st October 2021, the Company announced that the cum income Net Asset Value at the close of business on 30th September 2021 (the Company's year-end) was 568.97 pence per share. In line with the Company's distribution policy, the Directors declared the first quarterly interim dividend of 5.7 pence per share. Since then, two further dividend declarations have been made on 4th January 2022 and 1st April 2022, both of 5.7 pence per share. With the planned final quarterly dividend of 5.7 pence per share on 1st July 2022, the 2022 annual dividend will be 22.8 pence per share (2021: 22.8p).
Share Issuance during the Period
At the time of writing, the Company's issued share capital consists of 83,202,465 Ordinary shares. During the six months reporting period, the Company did not repurchase or issue any shares.
Board of Directors
John Misselbrook retired as Chairman following the AGM in January 2022. He joined the Board in July 2012, becoming Chairman in 2018. On behalf of the Board, I would like to thank John for his exemplary leadership and his significant contribution to both the Board and the performance of the Company.
After careful consideration, the Board invited me to succeed John as Chairman. Following the retirement of Oscar Wong and the appointment of three new Directors during 2021, the Board believes that the current number of five Directors is an optimal number and appropriate for the size of the Company.
Outlook and Strategy
The Company has navigated several periods of extreme volatility during the 28 years since its launch. In the short term, sentiment towards investing in China may well remain negative, given the uncertain prospects facing the global economy, the broader impact of the Russia-Ukraine war and China's dynamic COVID policy. Recent COVID lockdowns in selected Chinese cities have disrupted production and dampened consumption. Tightened restrictions on social activities and domestic travel since March have cast a shadow over the imminent recovery of the services sector and consumption.
That said, the Board continues to believe in the long term growth opportunities from investment in China. Supported by a well resourced and experienced research team in Hong Kong, China and Taiwan, our disciplined Investment Managers continue to find interesting companies in which to invest that are consistent with the structural growth bias of the Company's investment strategy. We remain confident that this investment strategy, combined with the depth of resources of our investment team, will enable us to deliver superior long-term returns.
Alexandra Mackesy
Chairman
24th May 2022
INVESTMENT MANAGERS' REPORT
During the six months to 31st March 2022, the Company delivered a total return on net assets of -30.8% (in sterling terms), compared to the benchmark return of -17.5%. While this performance is disappointing, it is not unusual for the Company to experience bouts of performance volatility over short periods. And the results for the review period stand in sharp contrast to the Company's track record of positive absolute returns and outperformance over the long term. The fund has outperformed its benchmark over three, five and ten years, delivering an average annualised return of +11.7% in net asset value (NAV) terms over the ten years to end March 2022, compared to a benchmark return of +6.9%.
Setting the scene
The past six months were a challenging time for the Chinese economy. Annual GDP growth decelerated from 7.9% in Q221, to 4.8% in Q122. Consumption remained constrained by China's very stringent dynamic COVID policy, which has seen large cities such as Xi'an, Shenzhen and Shanghai, with populations of over 10m, under strict lockdowns. While exports held up incredibly well, despite global logistic bottlenecks, investment weakened. The government's attempt to stabilise the economy by stepping up infrastructure investment was not sufficient to offset the drop in property-related investments following the government's efforts to deflate China's property bubble.
Credit risk in the property sector was heightened in September 2021 when Evergrande, one of the largest private property developers, failed to honour interest payments on some of its debt. However, as we discussed in our last report, we see little risk that any private developers' liquidity problems will trigger systemic risk. We expect Evergrande to solve its liquidity problem at the individual project level, with the support of local governments, which are coordinating assistance measures with banks, suppliers and other developers. And as expected, the government has begun to ease constraints on the property sector as a whole. Purchase restrictions are being loosened, households' and developers' access to capital is improving and the cost of credit is declining.
China is also facing the same headwinds as the global economy – inflation and the war in Ukraine. In the case of inflation, the impact has so far been less severe than in the US and certain developed countries, as labour shortages are not an issue for China and food inflation is being dampened by the low pork price. But inflation has nonetheless impacted corporates, putting pressure on the margins of companies that lack the power to pass cost increases on to their customers.
Russia's invasion of Ukraine has also had limited ramifications for our portfolio companies, beyond the indirect effect on energy markets. We do not have any investments in companies engaging in defence and military activities, and for those few holdings that have operational facilities in Russia, the contribution to revenues and profits from this market is low, around low single digit percentages on average. In terms of energy, China does import 9% of its pipeline natural gas from Russia, but pipeline gas is priced independently in each region. However, LNG prices may experience higher than usual volatility going forward and China imports about 8% of its LNG from Russia.
Performance commentary
Stock selection was the biggest detractor in performance over the review period, partially offset by sector allocation. Gearing also detracted.
Healthcare had the largest adverse impact on returns, due to some stock specific developments related to Wuxi Biologics , a contract research organisation, and two medical devices companies, Broncus Holdings and Venus Medtech . In February, two of Wuxi Biologics ' facilities in China were included in the US Commerce Department's 'unverified list', which prohibited it from importing certain equipment and consumables from the US. The company's share price declined on this news, despite its strong financial performance and management confidence that it will receive US regulatory clearance in a few months. Broncus and Venus Medtech are facing increasing pricing pressure from China's central government procurement system. We have reduced positions in all of these companies.
Financials detracted mainly because we did not own large state-owned banks such as China Construction Bank , Industrial & Commercial Bank of China and Bank of China . We do not like their tepid long-term growth prospects. However, they outperformed the benchmark during the review period, as concerns about asset quality eased and investors priced in further monetary policy loosening.
Performance was also hurt by our holdings in several internet companies, namely our overweights to Bilibili , a gaming and multimedia company, and internet retailers Pinduoduo , an ecommerce platform targetting the budget segment of consumers which sells clothing, household goods and auto accessories, and Meituan , which provides food deliveries and other consumer services. All have been affected by regulatory crackdowns. Bilibili's near term growth has been hindered by the delayed approval of new online games. Pinduoduo lacks a Hong Kong listing and was not able to provide a convincing explanation for it. This has raised concerns that it will be de-listed in the US if regulators on both sides cannot reach an agreement on access to audit drafts. In addition, growth in its core ecommerce business is slowing. We reduced positions in both Bilibili and Pinduoduo.
In the case of Meituan , the government recently published guidelines encouraging platform-based service companies like Meituan to support small and medium sized enterprises and employment in the broader service industry. Although not targeted at Meituan specifically, the guidelines were interpreted negatively by already nervous investors. However, we took this opportunity to add to our holding, as we remain optimistic about Meituan's long term growth prospects. It has abundant scope to expand its local service offerings.
Industrials made the largest positive contribution, mainly due to the continued strong performance of our overweight position in Contemporary Amperex Technology (CATL) , China's leading electronic vehicle (EV) lithium battery maker. Growth in its revenues, capital expenditure and margins continue to beat already-elevated market expectations thanks to the strength of global demand for EVs.
Sector allocation and transactions
Our largest holdings remained mostly unchanged during the review period. In the social media and online entertainment sector, we maintained our large positions in Tencent , the internet content and information giant, Bilibili and Netease , another electronic gaming and multimedia company. In healthcare, meaningful positions include Wuxi Biologics , Shenzhen Mindray Bio-medical and Asymchem Laboratories (see below). In technology, we hold enterprise software names Kingdee International and Baosight Software , and hardware names Starpower Semiconductor and Silergy Corp . In green technology, our largest positions are overweights in Tongwei , a producer of animal feed and polisilicon used in solar panels, and CATL .
While our largest holdings have been relatively stable, we have not been idle. We continue to build positions in areas where we see the greatest structural growth opportunities, namely Consumer, Technology and Healthcare and Green Energy. In fact, recent market volatility has increased the number of opportunities we see to invest in interesting companies with solid long term fundamentals, at attractive valuations. We have also adjusted exposure within these key sectors, to reflect our latest views following the annual result season and recent economic and geo-political developments.
In e-commerce, we completely exited internet retailer Alibaba and rotated into its rivals, Meituan , as discussed above, and JD.com . This switch reflected our view that Alibaba may struggle to return to high growth territory, even in a benign regulatory environment, while JD.com is, in our view, more likely to realise further growth in sales and margins. We also reduced exposure to companies hit hardest by China's severe COVID restrictions, including Huazhu Group , China's largest hotel group, and sportswear names ANTA Sports and Topsports International .
In an inflationary environment such as we currently face, companies with strong pricing power have particular appeal. For example, we initiated a new position in Chongqing Brewery , Carlsberg's China operation. This company has demonstrated strong brands and a capacity to develop new products appealing specifically to domestic consumers. We also added to selective property-related companies with solid balance sheets and long term growth opportunities, including customised furniture maker Oppein Home , home appliance supplier Haier Smart Home , and construction materials producer SKSHU Paint . All of these companies were trading at attractive levels following the government crackdown on China's overheated private property sector.
In the technology sector, we opened a position in software company Hundsun Technology , which has a dominant position in the supply of customised IT software systems to Chinese financial institutions. The IT budgets of these organisations are set to grow steadily, as China's capital markets become increasingly sophisticated and financial products replace property as the most popular investment channel. Our acquisition of Hundsun was funded by reducing our exposure to some of the sector's outperformers, such as semiconductor names Starpower Semiconductor and Montage . Some other disposals within this sector were based on our view that certain forms of discretionary consumption may remain sluggish due to COVID lockdowns. We reduced tech hardware names that are primarily exposed to consumer electronics, namely Sunny Optical , which produces smart phone lenses, and Maxscend Microelectronics , a supplier of smart phone radio frequency chips and switches.
In healthcare, we participated in the initial public offering (IPO) of Asymchem Laboratories , a contract development and manufacturing organisation (CDMO) mainly serving multinational pharmaceutical companies. Asymchem is highly valued by its clients for its technical capabilities, that help them accelerate drug launches and reduce associated costs. We also initiated new positions in Qingdao Haier Biomedical , a medical equipment and services provider, and Acrobiosystem , a bio-reagent company specialising in the design and production of proteins for a wide variety of customers including biomedical research institutions and biotech companies. Both of these companies provide us with quality exposure to China's fast growing biomedical industry, with relatively low regulatory and product approval risks. However, we exited Hengrui Medicine and Hualan Biological on the back of pricing headwinds and disappointing new product pipelines. We also reduced a couple of small cap pharmaceutical and medical device companies that generate almost all their revenue within China and will therefore face continuous pricing pressure from centralised procurement policies.
In the green energy space we broadened our exposure on the view that this sector will require high levels of private and public investment if China is to achieve its target of zero carbon emission target by 2060, while simultaneously strengthening its energy independence. We initiated new positions in China Longyuan Power , the country's largest wind power generator and NARI Technology , which provides 'smart' products and services necessary to run China's power grid as it transitions to renewable energy. We also bought Sungrow Power Supply , the world's largest solar panel inverter maker. These trades were partially funded by continuous reductions of outperformers CATL , LONGi Green Energy and Yunnan New Energy Materials .
In terms of gearing, the distressed valuations and associated opportunities we see in some areas led us to increase portfolio gearing almost 20% during the period.
Outlook
Global economic growth is facing mounting pressure from inflation, interest rate rises in the US and the UK and the war in Ukraine. In China, growth is likely to remain below trend. The government's dynamic COVID policy is delaying the service sector recovery, and manufacturing activities are also being disrupted by factory closures. We expect this policy to remain in place until most elderly people are vaccinated. Meanwhile, as lockdowns persist, manufacturing activities, the backbone of the Chinese economy, are being protected and prioritised over consumption. While energy prices in China may be insulated to some extent by existing supply and pricing arrangements with Russia, food prices are likely to increase due to shortages of grain, oil and fertilisers created by the war in Ukraine. All these factors are likely to impose downward pressure on corporate earnings, at least for the short term.
To offset the disruptions caused by COVID, as well as to ease pressure on the property sector, the Chinese authorities continue to loosen monetary and fiscal policy. But realistically, it may take time for these efforts to take effect, as consumer and business confidence and activity will not be restored until restrictions are lifted and daily life returns to some semblance of normality.
Elsewhere on the regulatory front, we are seeing some positive developments. China's Vice Premier Liu He hosted a meeting with the Financial Stability and Development Committee of the State Council to orchestrate a policy shift away from the deleveraging and de-risking measures imposed in the past couple of years, towards economic stabilisation and capital market development. One step in this direction is an apparent easing of regulatory controls on the internet sector. After an eight month hiatus, the government recently granted 45 publishing licences for domestic games – a meaningful concession that has boosted confidence in the outlook for the whole sector. And in April, the Politburo of the Chinese Communist Party announced that the 'rectification' of internet platforms is approaching completion and that it supports the healthy development of platform companies within this new regulatory framework.
Furthermore, tensions between China and the US seem to be diminishing. In March 2022, the Chinese Securities Regulation Committee announced that it was drafting policy which will give US regulators full access to the financial accounts of most US-listed Chinese companies. If an agreement on this issue can be reached, it will significantly reduce the delisting risk for Chinese companies listed in US. On the US side, the Biden administration has extended tariff exemptions on key Chinese imports until the end of 2022, to ease US inflationary pressures.
Although, as ever, China faces near term challenges, we remain optimistic about the long term prospects for Chinese equities, which will be supported by the admirable entrepreneurial spirit of China's private businesses and continuous improvements in living standards. The government's strong determination to digitalise, adopt other technological innovations and implement supply side structural reforms will also drive growth and productivity improvements over the medium term. In addition, recent market volatility has ensured that the valuations of Chinese equities are now very attractive. Our proprietary, five-year expected return model, as well as common market metrics such as price/earnings (P/E) and price to book (P/B) ratios, have all reached historical lows, suggesting that a strong, and protracted recovery in Chinese equities is soon likely.
We remain confident of our capacity to navigate the kind of short term market volatility we have experienced in recent months. We will continue to seek investment opportunities in those sectors best placed to benefit from secular trends and the government's long term policies. This tried and tested approach will, in our view, continue to provide positive returns and outperformance for our shareholders over the longer term.
Howard Wang
Rebecca Jiang
Shumin Huang
Investment Team
24th May 2022