Market Review

The Greater China equities market was one of the best performing equity markets during the month of August. The MSCI China Index rallied, gaining 7.37% (in US dollar terms).

China's macroeconomic picture remains mixed. Fixed asset investment weakened sharply in July. In comparison, consumer sentiment remained largely resilient. The strength of discretionary spending was reflected in the quarterly results of China's internet giants, such as Tencent Holdings Ltd. and Alibaba Group Holding Ltd. We expect this divergence to continue. Hong Kong's second quarter 2016 GDP growth was a pleasant surprise, largely due to weak figures during the same period last year. However, soft retail sales and consumption data combined with a fragile global economic recovery still weighs on investors' near term confidence.

Separately, there was positive news on the financial reform agenda in China. The long awaited Shenzhen - Hong Kong Stock Connect Scheme was finally approved by the Chinese State Council in mid-August, and it is expected to be operational before the end of 2016. This is an important step towards expanding China's capital account, following the launch of the Shanghai - Hong Kong Stock Connect almost two years ago. This increases the long term probability that China A-shares will be included in MSCI indices. The new Shenzhen - Hong Kong Stock Connect Scheme will extend access for international investors to more of China's 'new economy' stocks. Almost 60% of the Shenzhen stock market capitalization is in consumer staples, consumer discretionary, health care and IT companies. It is worth noting that many of these names are small and mid-cap companies that trade at a significant premium compared to their Hong Kong listed peers. As a result, Hong Kong listed small and mid-cap companies showed signs of strength against the broader market in the second half of August.

Fund Review

During the month, the Fund's Net Asset Value ("NAV”) price outperformed the MSCI Golden Dragon Index (the "Benchmark Index”). The Fund benefited from our positioning in small and mid-cap names, such as Semiconductor Manufacturing International Corporation, a small-cap semiconductor foundry in China, which was the top contributor in August. In our view, this company is well positioned to provide semiconductors to domestic customers as a substitute for foreign imports. The company's recent better-than-expected second quarter 2016 earnings reflected strong domestic demand in China, as well as the company's capability to maintain good operating margins while continuing to add production capacity, which will contribute to future growth. The share price rallied more than 30% during the month, coming from a very low valuation base. We believe the share price has room to grow in the medium to long term, driven by both improved investor perception and earnings growth.

Key Transactions

In August, the main detractor to relative performance was Sun Hung Kai Properties Ltd., a leading property developer in Hong Kong, whose share price traded sideways in August after a strong rally in July, lagging the Benchmark Index. Fundamentally, we like the company's good public reputation and strong execution track record, which we feel will help drive earnings growth with a strong project launch pipeline. The low gearing ratio, stable recurrent rental income and strong property sales should support the dividend payout and underpin the share price over the medium term.

Outlook

Even after the rally in recent months, Greater China equities are still one of the laggards among emerging markets year-to-date. On a number of valuation methods, Greater China equities are reasonably priced. For example, the dividend yield of China equities listed in Hong Kong is close to 4%. This is one of the highest levels around the world, supported by improving corporate cash flows, which are a result of disciplined capital spending and tighter cost control. This is a positive development, as stable and even increased future dividend payments, in our view, will be supportive for Greater China equities.

 

Performance (US$ Returns)

(as of 8/31/16)

	Fund	Benchmark1
One Month	5.54%	4.64%
Three Month	11.86%	12.19%
One Year	8.16%	11.31%
Three Year	5.81%	6.18%

 

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The investment objective of the Fund is to achieve long-term capital appreciation. The Fund seeks to achieve its objective through investment in the equity securities of companies and other entities with significant assets, investments, production activities, trading or other business interests in China or which derive a significant part of their revenue from China.

The Fund has an operating policy that the Fund will invest at least 80% of its assets in China companies. For this purpose, 'China companies' are (i) companies for which the principal securities trading market is in China; (ii) companies for which the principal securities trading market is outside of China or in companies organized outside of China, that in both cases derive at least 50% of their revenues from goods or services sold or produced, or have a least 50% of their assets in China; or (iii) companies organized in China. Under the policy, China means the People's Republic of China, including Hong Kong, and Taiwan. The Fund will provide its stockholders with at least 60 days' prior notice of any change to this policy.

	Fund	Benchmark1
P/E Ratio	14.38	13.49
P/B Ratio	1.50	1.42
Issues in Portfolio	43	283
Foreign Holdings (%)	98.25	100.00
Other assets & liabilities (%)	1.75	0.00
Yield (%)	2.89	2.83

 

Source: IDS GmbH - Analysis and Reporting Services, a subsidiary of Allianz SE.

 

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