Chinese funds are struggling. Is there hidden value in them?

These funds have been seesawing since the beginning of the last calendar year,. Between January 2022 and October 2022, they were down 32-44%. However, between November 2022 and January 2023, they were up 40-57%. And, since January, these funds have declined 13-19% as the Chinese economy continues to face setbacks in its recovery.

So, should investors stay put in hopes of a recovery or look elsewhere to reduce the volatility in their portfolio?

What went wrong?

Chinese funds were seeing a sharp recovery between November 2022 and January 2023 as mentioned earlier. The recovery was triggered as China eventually started to ease covid-related restrictions in November.

But, since then, the performance of Chinese funds has been weak. For instance, Edelweiss Greater China Off-Shore Fund, which is the largest and oldest fund in the category (see graphic), has delivered negative returns of 12.7% in the year-to-date period. Nippon India ETF Hang Seng BeES has delivered negative returns of 10.7% in the same period. Mirae Hang Seng TECH ETF saw a dip of 11.3%, while Axis Greater China Fund of Fund (FoF) declined 10%. The weakness in the returns of these funds can be attributed to a slowdown in China’s economic recovery.

 

According to Nomura’s report, China’s post-covid recovery has been a concern. Following the scrapping of the zero-Covid policy, the economy saw a rebound, but the report points out that not all data points coming out of China have been encouraging.

“Activity data in April and high-frequency data in May showed that the recovery has been losing steam, partly due to weak confidence among consumers and business investors," Nomura said in its report. This data refers to manufacturing and services activity.

To compound matters, China’s property sector, accounting for one-third of China’s GDP (gross domestic product), is going through a debt crisis. The large number of defaults by private property developers have led to unfinished residential units, non-performing loans for banks and loss of employment for those working in the property sector. The slowdown also doesn’t bode well for related sectors such as building material suppliers.

However, recent data points are encouraging. “There have been positive signs given the robust industrial profit number in China and factory activity expanding for the first time in six months," says Niranjan Avasthi, senior vice president at Edelweiss Mutual Fund.

China vs emerging markets

Despite the challenges, China still remains the largest economy among the emerging markets and second largest economy in the world with GDP of $17.78 trillion.

Within the MSCI Emerging Market Index, China’s weightage is nearly 30%. India follows with 15.6%, just slightly above Taiwan. There are as many 41 exchange traded funds (ETFs) globally that track the Chinese market, including actively- and passively-managed ETFs that track various indices. Between them, these funds manage investor assets worth $27.6 billion. However, the MSCI China Index – which is used by foreign investors to track Chinese markets -- has underperformed both the MSCI Emerging Market Index and MSCI India Index.

The MSCI China Index has generated negative returns of 7.3% in the year-to-date, while MSCI Emerging Market Index has generated 1.8% returns during this period. On the other hand, MSCI India Index has been up 8% in the same timeframe.

“Investors have made money in the Chinese markets in the past. Given the large size of the economy and China being a significant part of the global indices, foreign institutional investors are likely to continue to be exposed to China as long as the benchmark indices have a China weightage. Meanwhile, some of the non-real estate sectors of the Chinese economy continues to show some resilience," says U.R. Bhat, co-founder and director of Alphaniti Fintech.

What should investors do?

Economists expect China to eventually stage a recovery. There have already been signs of a pick-up as the Chinese government has reopened the economy by easing covid-related restrictions. The World Bank expects China to log 5.1% economic growth in 2023. In 2022, the economy grew at 3%, which was one of the worst growth rate in the country’s history. The Chinese government has also started to take measures to stimulate the economy, particularly property sector, by cutting interest rates.

How quickly can these measures revive the economy? Only time will tell. For now, Chinese funds can be a tactical investment opportunity for investors who want to place a contrarian bet on the Chinese economy. However, only investors with tolerance for higher volatility should consider such funds, as changes in government policies have a stronger bearing on Chinese markets.