In March, there was a significant price correction and volatility in Chinese equities and in the Acatis Qilin Marco Polo Asia Fund. An accumulation of market risks in the first weeks of March led to one of the strongest sell-offs in Chinese equities since the first Covid outbreak in 2020. However, for the first time, China's highest regulatory body, the State Council, officially pledged to support the economy and capital markets with specific "commitments" to address some of these challenges, leading to the highest share price increase in Chinese equities in one day since 2008.
In summary, the price correction and volatility were due to a combination of challenges that roiled the markets in a "perfect storm". The individual challenges and uncertainties include the following:
China's role in the Russia-Ukraine conflict:
Russia's alleged request to China for support, including military equipment and critical goods such as semiconductors, sparked concern about possible serious US and European sanctions against China. Investors were concerned that, in terms of sanctions, the "Russia of today" could be the "China of tomorrow."
China's Covid-19 Lockdowns:
China's Zero-Covid strategy has historically been very successful in containing the virus. Investors have questioned whether this approach will work with Omicron. The recent resurgence of Covid-19 in China has resulted in the lockdown of Jilin Province, parts of Shenzhen (China's high-tech hub), Shenyang, and Shanghai. Investors were concerned that these lockdowns would have a significant negative impact on high-tech supply chains, manufacturing and exports, as well as domestic consumption.
China's Tech Regulations: 2021 was marked by a flood of Chinese regulations. In March 2022, new regulations on the technology sector included limiting the amount of time spent by minors on Internet platforms and fines of several hundred million of RMB to Tencent over its allleged violation of anti-money laundering regulations through its Wechat Pay app. Consequently, investors' concerns regarding further significant regulations in the tech industry have resurfaced.
U.S. Delisting Risks: The US Securities and Exchange Commission (SEC), starting in 2020 under Donald Trump, announced that Chinese ADRs who do not fully disclose their books to the American authorities by 2024 would be de-listed. In March this year, the SEC published the names of 5 U.S.-listed Chinese companies that could be subject to delisting in three years time should they not undergo an audit inspection by an accounting firm approved by U.S. authorities. Although this is not a new issue, investors' fears regarding potential delistings and thus illiquidity resulted in a pull-back from all Chinese companies listed in the US.
China Growth Concerns:
China recently announced a higher than anticipated GDP growth target of 5.5%. Many investors are skeptical that this goal could be achieved given the challenges listed above.
The resulting market corrections prompted China's highest state body, the State Council, to address 3 of these 5 concerns in detail. In particular, China promised to:
1. Stabilize the stock market , including the Hong Kong market
2. Bringing an end to regulations in the tech industry
3. Addressing the risks in the real estate market
4. Support foreign listings of Chinese companies
5. Work out a solution to the ADR problem with the USA.
This was the first time that there were official Chinese "commitments" to addressing the risks of tech regulations, US delisting risks and growth concerns due to the real estate crisis. These commitments led to the highest one-day rise in Chinese equities since 2008. The MSCI China All Shares gained 8%. Leading tech companies such as Alibaba, Tencent, Baidu, JD.Com and Meituan gained between 20-35%. The Acatis Qilin Marco Polo fund gained almost 10% that day.
With regard to the unaddressed risk of China's role in the Russia-Ukraine conflict, we anticipate that the probability that China will actively take Russia's side and thus expose itself to Western sanctions is low to moderate. However, the remaining risk of a strong Covid-19 outbreak must continue to be taken into account.
With regard to our portfolio strategy, this results in the following thrusts:
Complete exit from US N-Shares (already implemented)
Although China has announced finding a solution to the delisting problem, we want to completely eliminate the risk of delisting and illiquidity. As such, we have already completely withdrawn from the N-Shares in recent months.
Remaining invested in Chinese technology companies Chinese tech companies have suffered greatly from government regulations in 2021. We believe that the new regulatory conditions have largely been priced in and that in many cases the adjustments have been too strong. With the government's commitment that regulations are coming to an end, we see potential here.
Maintain our exposure to the Hong Kong stock market (where over a third of our portfolio companies are listed) The Hong Kong stock market is at a 5-year low. With the commitment to strengthen the entire Chinese stock market and to strengthen the coordination between the Chinese and Hong Kong markets, we also see potential here.
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