The performances of Chinese stock markets were mixed in 4Q2021, with the CSI300 up by 1.5% but HSCEI down by 5.6%, finishing the year on a weak note, with CSI300 and HSCEI indices down 5.2% and 23.3% for the year, respectively. Our Chongyang Dynamic Value Fund (“the Fund”), however, delivered a reasonably good performance in 2021 in terms of both relative and absolute returns by posting an annual return of XX%.

The divergent performances between A and H shares in 4Q21 could be explained by the following factors. First, as the economic downturn deepened, the component stocks in H shares tend to be more sensitive to the macro cyclical conditions than A shares whose components are more diversified in terms of sectors and styles. Second, while both A and H shares share the same economic fundamentals, H shares are more exposed to the offshore liquidity conditions which started to tighten as the US Fed turned increasingly hawkish. Third, relative to onshore investors, proportionately more offshore investors seem to have subscribed to the view that Chinese stocks deserve to be permanently de-rated due to lack of policy transparency and predictability.

In retrospect and from a top-down perspective, for the year of 2021 as a whole, we think the overall weak performance of Chinese stock markets--including both onshore and off-shore listed shares--could be attributed to at least three factors: 1) a premature policy tightening--on monetary, fiscal, and property fronts--exacerbated by the zero-Covid policy that had led to a number of local lock-downs throughout the year across the country; 2) the blunt and draconian regulatory measures targeted at several industries (e.g., education, platform tech companies), which had not only dealt a severe negative shock to these specific industries but also greatly increased the overall risk premia of Chinese equity markets; and 3) a negative terms of trade shock caused primarily by the elevated commodity and energy prices as a result of the global recovery, which had driven a sizable wedge between PPI and CPI inflation in China and generated substantial cost pressures on mid- and down-stream industries.

The key reason for the good performance of the Fund in 4Q21 is that the gains from its exposure to A shares more than offset the losses from its exposure to H shares in the portfolio. In particular, our A-share positions on the industrials and consumer discretionary sectors delivered decent absolute returns, while our H-share positions outperformed the markets by a significant margin thanks to the remaining defensive positions on utilities and financials in our portfolio. That we had lowered our overall risk exposure in the beginning of 4Q21 also helped.      

Looking ahead, we have turned more bullish on the market outlook and begun to raise our overall risk exposure from the end 4Q21 level. As discussed in our previous quarterly newsletter published in October 2021, we thought “it’s too early to become outright bullish yet, despite the substantial market corrections.” (see Quarterly Newsletter -- Third Quarter 2021). A key reason for our cautiousness back then was that “While the current momentum on both consumption and investment remains weak, we have not yet detected a decisive shift in either fiscal or monetary policy stance...”. However, at the Central Economic Work Conference (CEWC), China’s highest level economic policy meeting that takes place at the end of each calendar year, Chinese authorities have made nothing short of a decisive policy shift from tightening toward easing on monetary, fiscal and regulatory fronts. PBoC has subsequently delivered both RRR and interest rate cuts and signaled more dovish moves to come. If history is any guide, we think the unfolding policy easing will likely turn out to “overshoot” rather than “underwhelm.” In fact, even though China’s latest money and credit numbers are still fairly weak, the credit impulse--our favorite indicator of the liquidity cycle--has begun to rebound, signaling a quick second-order improvement. We expect China’s growth will bottom out and even start to accelerate by mid year.

On the regulatory front, we continue to believe that the most severe phase of the policy shocks to the targeted industries is behind us. In this connection, we have often been asked by our investors whether it is just normal regulatory consolidation or a paradigm shift. Our answer is that it is the former but with “Chinese characteristics”. To be sure, we understand why some China observers think it is a paradigm shift. This perception gap has to do the particular way of Chinese authorities’ implementing major policy changes. These changes are typically executed in a campaign style with a shock and owe effect in the short run, even when the substance of the relevant policy measures is well intended and justified in and of themselves for the long term benefit of the economy and society. Should the policy implementation in China be improved? Absolutely yes. Even some senior Chinese officials publicly acknowledge these short-comings and call for improvement. But we are afraid this would be a reality in China for the foreseeable future, which we investors need to deal with strategically.

When it comes to construction of investment portfolio, we believe that it will continue to be a stock picker’s market as was the case last year. We aim to maintain a well-balanced portfolio and avoid taking concentrated positions on any particular sector. We would nevertheless like to highlight two types of opportunities: the first type is with select names in manufacturing sector, whose investment case can be made by a combination of great long-term growth stories (e.g., import substitution) and near-term catalysts (e.g., easing of cost pressures); the second type of opportunities is with some IT and healthcare names which, we believe, have been oversold out of unjustifiable concerns about the regulatory risks.