China investment trusts, Photo by 嘲 风 on Unsplash

China Investment Trusts Come Of Age

The Chinese stock market has been one of 2020’s top performers. Up 19% in sterling terms, it’s well ahead of the US’s 10% gain and the UK’s sickly 19% drop.

For a long time, though, investing in China has been both difficult and disappointing.

Take a look at the MSCI China index and you’ll see it’s up just 2.5% a year (measured in US dollars) since the start of 1993. That’s miles behind the 8% a year posted by global markets.

Chinese stocks fell throughout the 1990s, while the rest of the world boomed. They were then flat before several years before exploding into life just before the financial crisis.

They rose 83% in 2006 and 66% in 2007 before crashing hard the next year and trailing the rest of the world through the first half of the 2010s.

At that time, financial companies dominated the Chinese index. There were concerns that Chinese banks were still overextended and numerous examples of China-based companies listed in the US and UK that rather exaggerated the extent of their operations.

The rise of Chinese tech

But a lot has changed over the past few years. Financials now account for just under 14% of MSCI China.

That means both Alibaba (20%) and Tencent (14%) are now larger than the entire Chinese financial sector.

Other large tech stocks in MSCI China’s top 10 include Meituan Dianping (a local food shopping platform), JD.com (online retail), NetEase (computer games), and Baidu (search engine).

Over the last five years, the Chinese stock market is up 14% a year versus the world’s 11%.

Admittedly, the US has performed better at nearly 15% a year, but it’s only marginally ahead.

There are 16 Chinese-based companies valued at more than $100 billion. The UK has just four (Unilever, AstraZeneca, BHP and GlaxoSmithKline).

May you invest in interesting times

A lot of China’s poor stock market returns occurred when its economy was growing rapidly.

At the start of this century, China’s GDP was about 25% of Japan’s and around 10% of the US.

By 2010, China’s GDP had exceeded Japan’s, making it the world’s second-largest economy, and was around 40% of US GDP.

The gap has continued to close. In 2019, China’s GDP was 66% of the US’s.

If current trends continue, China looks set to overtake the US by 2030ish but the two countries may be fairly evenly matched after that.

Major countries GDP trends

Now, there are plenty of folks who cast doubt on the steady-looking figures published for the Chinese economy.




But few would dispute that it makes up some 15% of the world’s GDP, give or take the odd percentage point, and is the second-largest in the world by a considerable margin.

Where China fits into world markets

There are a few complications for investors wanting to invest in China.

First, its weighting in most global indices generally understates the importance of its economy.

Developed world global trackers typically have no significant exposure to Chinese stocks (even those with US listings) as China is not classed as a developed market. Hong Kong is counted as a developed market but its weighting is only 1%.

Whole world trackers, like Vanguard’s All-World ETF, do include China but the country’s weighting is typically just 5%, far below the 15% or so of world GDP that the country represents.

Many people use the expanded definition of Greater China (which adds in Hong Kong and Taiwan) but that still only takes you to around 7.5% of whole world trackers.

An emerging solution

One way of correcting for this, if you feel you need to, is to include an emerging market tracker in your portfolio. China makes up about 45% of most emerging market indices with Taiwan adding another 15% or so.

That means Greater China dominates emerging markets in a similar manner to the way the US dominates developed markets.

India comes a distant second at 10% of emerging markets, with Brazil 7%, South Africa 4%, and Russia and Saudi Arabia at 3%. If you’re happy investing in these countries as well, then an emerging markets fund could be the ticket.

Presumably, at some stage, China will be classed as a developed market but that’s probably a few years away.

MSCI doesn’t seem to have a precise definition of what constitutes a developed market and moves between emerging and developed are relatively rare.

Portugal was promoted to developed in 1997 and Greece followed it in 2001 only to then be demoted again in 2013. Israel moved up to developed in 2010.

A shares, B shares, H shares

Another issue for those wishing to invest in China is the different share classes.

A shares are primarily for Chinese residents and certain institutions. They were only introduced to the MSCI China index in 2018, which led a large jump in China’s emerging market weighting.

Then you also have B shares, which non-Chinese residents can buy.

And there are H shares that are listed in Hong Kong.

Finally, some Chinese companies are listed in the US as ADRs.

Most funds and trusts investing in China seem to use all of these different methods, something most private investors would struggle to replicate.

Getting China exposure via trusts

There are various ways to invest in China using an investment trust.

Most mainstream global trusts typically have 5-10% in Greater China, similar to whole world trackers. Scottish Mortgage is the outlier with 20%.




Emerging market trusts have quite a mixed exposure, with Fundsmith Emerging Equities at the low end (20%) and JPMorgan Emerging at the high end (50%).

The various Asia Pacific trusts, some of which have an additional focus on income or smaller companies, have a similarly wide range of exposure to Greater China.

Tech and biotech/healthcare trusts, two popular growth themes, seem a little light on Chinese stocks right now, mostly holding just a few per cent.

Ten trusts invest in single Asian Pacific countries but only two specialise in China. However, there are four Indian trusts and three for Vietnam.

The two Chinese trusts are fairly chunky, though. Fidelity China Special Situations has a market cap of £1.6 billion while JPMorgan China Growth & Income is nearly £400m.

They should soon be joined by Witan Pacific, whose shareholders are due to vote on a change of investment focus and manager next week.

Assuming the plan is approved by its shareholders, Witan Pacific is to be renamed Baillie Gifford China Growth Trust. Its aim is to hold between 40-80 listed and unlisted Chinese companies, with up to 20% of the portfolio in unlisted. [Note: shareholders approved this deal on 16 Sept]

Witan Pacific’s current market cap is just £225m although a tender offer accompanying the vote could see this shrink by up to 40%, depending on the extent its existing shareholders want to cash out.

The refocused trust will share two of the three managers that run the Baillie Gifford China open-ended fund. This was launched in 2008 and it is second out of twenty-one China open-ended funds with a ten-year record.

Chinese trusts compared

So we have a trio of contenders. Let’s look at their top ten holdings.

As Baillie Gifford China Growth Trust is yet to become official, I’ve used the latest holdings for the Baillie Gifford China open-ended fund instead.

JPMorgan China
Growth & Income
Fidelity China
Special Situations
Baillie Gifford
China
Tencent 9.9%Alibaba 14.5%Alibaba 9.6%
Alibaba 9.1%Tencent 14.1%Tencent 9.5%
Wuxi Biologics 3.6%Meidong Auto 4.5%Ping An Ins 5.6%
Kingdee 3.3%21Vianet 3.8%JD.com 4.6%
Meituan Dianping 3.2%Skshu Paint 3.2%Meituan Dianping 4.3%
Pinduoduo 3.0%WuXi AppTec 3.0%Kweichow Moutai 3.6%
Ping An Ins 2.9%Ping An Ins 2.9%China Merchants Bank 2.4%
NetEase 2.7%China Pacific Ins 2.6%NetEase 2.3%
Jiangsu Hengrui 2.0%Noah Holdings 2.4%Guangzhou Kingmed 2.1%
TAL 1.8%Hutchison China Med 2.3%CATL 2.0%
Top ten: 41.5%Top ten: 53.3%Top ten: 46.0%

At first glance, you might think there’s not a lot of difference between these holdings and the Chinese index, thanks to the heavy weighting of all three portfolios towards Alibaba and Tencent.

But even Fidelity China Special Situations is underweight the 35% level these two companies are within the MSCI China index.

Look further down the list of holdings, Ping An Insurance is the only other company to make all three top tens.

Most of the other big China tech stocks feature, but none are held in all three top tens.

Only the smallest of the big five China banks appears and only in one top ten. What’s more, there is no Petrochina, China Mobile, or Baidu.

So there is a fair amount of divergence between these portfolios and the China index. In other words, these aren’t closet trackers.

The top tens are fairly concentrated but other than Alibaba and Tencent, there are only four other holdings over 4%.

Similar strategies

Fidelity China Special Situations can hold up to 10% of its portfolio in unlisted companies. Its past unlisted successes include Alibaba and Meituan Dianping.

FCSS had 6% of its assets in unlisted as of March 2020, including a small position in ByteDance, the owner of TikTok.

According to FCSS’s manager, Dale Nicholls:

“tensions between China and the US will be with us for decades to come”; and

“the impact of the virus is likely to accelerate several of the structural shifts already underway, such as the shift to e-commerce and various online services. A significant weighting in such holdings should see the Trust benefit from such trends.”

JPMorgan China Growth & Income can also hold up to 10% of assets in unlisted companies but doesn’t appear to be using that facility at the moment. According to its managers:

“the portfolio continues to seek out higher-quality businesses in sectors where we see structural growth opportunities, namely in the Consumer, Health Care and IT sectors; we remain confident that secular growth trends here will not be derailed by the Covid-19 pandemic.”

Baillie Gifford is following a similar strategy across most of its funds and trusts, so you could make a case for all three China investment trusts following a pretty similar quality/growth approach, even if the make-up of their portfolios is a little different.

Have we seen the best gains already?

It’s tempting to think that China’s gains have all been about Alibaba and Tencent. Certainly, they have been a big factor in the recent growth of the Chinese market.

Alibaba is up 200% since listing in 2014, while Tencent is up 1,650% over the last decade and an incredible 65,000% since 2004.

Now they are both worth several hundred billion dollars, their future growth rates are likely to be lower of course.

Like many Chinese companies, most of their revenues come from China meaning they are far less ‘global’ than the big US tech stocks.

However, as China is growing more quickly than the rest of the world, you could argue that their medium-term growth prospects are fairly similar.

Side by side

Here are a few more comparators:

JPMorgan China
Growth & Income
Fidelity China
Special Situations
Witan Pacific/
Baillie Gifford
China Growth
TickerJCGIFCSSWPC/BGCG
Market cap£380m£1,620m£225m
ManagersHoward Wang
since 2006
Rebecca Jiang
since 2017
Dale Nicholls
since 2014
Sophie Earnshaw
Roderick Snell
from 2020
Listed199320101907
Charges1.3%1.0%1.0%
Discount5%7%3%
Gearing8%21%0%
Yield2.8%1.4%1.9%
2020 YTD+47%+41%** +32%
Last 10 years+304%+235%** +232%
Holdingsc75c14040-80

** These are the figures for the Baillie Gifford China fund rather than Witan Pacific.

A few things stick out here for me. The JPMorgan trust, known as a few different names since it launched, has the longest China-specific history.

Earnshaw and Snell both have several years of experience at other Chinese and Asia Pacific funds and trusts, but appear to be the youngest managers from this group.

There isn’t much to choose in terms of charges right now. Both the JPMorgan and Fidelity trusts have a 0.9% basic management fee, but Fidelity also has a performance element meaning it can vary up or down by 0.2 percentage points.

Baillie Gifford China Growth is to have a tiered management fee starting at from 0.75% and at 0.55%  over £250m. So if it grows in size, particularly if it trades at a premium and can issue new shares, it could become the cheapest of the three.

The discount levels are pretty similar right now although they have narrowed considerably in recent years.

The curse of the star manager, part 489

Fidelity China Special Situations traded at a premium for its first year after launch, thanks to the appeal of star manager Anthony Bolton, who had a very successful run as the manager of UK-focused Fidelity Special Situations.

It was big news at the time, raising £460m when it floated in 2010 and a further £166m via a C share issue early the following year.

The honeymoon period was brief, though, with the shares down almost 30% eighteen months after they listed.

By the time Bolton handed over the reins in April 2014, the trust’s shares were up 6% versus a 6% fall in the MSCI China index.

Gearing and dividends

The Fidelity trust carries a much higher level of gearing. Baillie Gifford China Growth can gear up to 20%, so its figure is likely to rise.

On the dividend front, the JPMorgan China Growth & Income is one of a few JPMorgan trusts that set their dividend at 4% of net asset value. JCGI only adopted this policy earlier this year. The cut-off point is its year-end, 30 September, so its dividend yield should jump to nearer 4% in due course.

Dividends for Baillie Gifford China Growth may fall over time, given the fund manager’s preference for growth stocks. Its China open-ended fund only pays out 0.6%. However, this trust has pledged to pay out the same level of dividend, 7.15p, for the years ending January 2021 and January 2022 and it has three years’ worth of revenue reserves.

Long-term returns

Performance-wise, the JPMorgan trust has the edge in 2020 and over the last 10 years. However, it’s performance before that reinforces just how difficult the China market was for a long time.

Those investing at launch in October 1993 were still flat in March 2009, nearly sixteen years later. Ten years after launch, they would have been down by around 50%.

However, I reckon all three of these trusts have managed to beat both the MSCI China and MSCI Golden Dragon indices (China, Hong Kong, and Taiwan) over the last 10 years, which I think is up around 160-170% in sterling terms.

They also compare favourably with 21 open-ended China funds, which range from +40% to +255% with an average of around +150%.

In summary

There aren’t a lot of China-focused investment trusts to choose from but, on this quick inspection, all of them look pretty promising.

Baillie Gifford is betting big on China, across many of its existing funds and trusts, so it’s going to be interesting to see how this new trust carves its niche. Its increased focus on unlisted investments may well provide that, although it could take a few years for it to build up to 20%.

I’d expect all three of these trusts to be quite volatile, as Chinese markets have been in the past.

Although I’ve moved away from regional and country-focused investment trusts in recent years, there seems to a decent case for making an exception when it comes to China.


Please note that I may own some of the investments mentioned above. You can see my current holdings on my portfolio page and the index page summarises my posts by category. Nothing in this article or on this website should be regarded as a buy or sell recommendation as this site is not authorised to give financial advice. I'm just a random person writing a blog in his spare time. Always do your own research and seek financial advice if necessary!


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