The Liontrust Asia Income Fund had slightly over 40% exposure to Hong Kong and China at the start of the year. All of this is via companies listed in Hong Kong (not A-shares, listed in the Chinese mainland markets), but they are companies with exposure to the mainland Chinese market, rather than the Hong Kong economy, which we think will struggle in a world of rising United State interest rates.
This is the largest geographical weighting within the portfolio, reflecting a generally positive view on certain specific areas of the Chinese economy, but also marks a reduction from approximately 45% at its peak. The reduction comes after a period of strong performance in 2016.
Much of the equity strength has reflected a confluence of positive factors in the Chinese economy. Rate cuts in 2015 took interest rates to accommodative levels which were maintained throughout 2016, which helped those with high debt burdens and benefitted areas such as property. Government spending also continued, much of it in long-term infrastructure projects, which combined with recent cuts in capacity to improve material prices. This was further aided by the United States’ promise that whichever party won last year’s election would increase American infrastructure spending.
We think that Trump’s infrastructure promises will not deliver too much immediate commodity demand, however, and we also see the Chinese stimulus reducing as property tightening measures are already being implemented. This does not make us negative, but it does reduce the short-term positives.
Beyond this there are two elements that have pushed us to lower exposure: ongoing high levels of bank lending – still rising at almost double GDP growth – and the renewed sharp reductions of foreign exchange reserves (averaging approximately US$50bn per month for the last quarter of 2016).
We do not see either of these as a prelude to disaster, but as we have argued for some time the failure to cut lending and ongoing large reduction in reserves does increase risks for the economy.
The fund’s current positioning reflects this rising risk. Our exposure remains very selective, and does not cover the broader Chinese equity market, but we can still find plenty of companies where we think valuations look attractive, and which provide the combination of dividend yield and earnings growth that we are seeking. These tend to be in areas of domestic consumption or those with government support, which are areas we have liked for some years now.