Abrdn China (ACIC ) endured a difficult first year as it focused on the world’s second-biggest economy, but portfolio managers Nicholas Yeo and Elizabeth Kwik are doubling down as conditions improve, borrowing more to invest in their top themes.

The £268m trust was created from the merger of Abrdn Emerging Markets and Abrdn New Thai in 2021, operating under a changed mandate that saw it ditch emerging market funds and stocks to focus purely on Chinese equities.

The first financial year to 31 October in its new guise was tough, China’s pandemic recovery was hampered by its strict zero-Covid-19 policy, the property market faced collapse, and the government clamped down on the technology sector. There were also overarching geopolitical tensions linked to Taiwan and China.

This storm of problems overshadowed the fund managers’ hope that China would be a ‘counter-cyclical recovery play’ thanks to modest stock market valuations, low inflation, and expansionary monetary policy. Net asset value (NAV) tumbled 37% in the 12-month period, falling behind the MSCI China All Shares index, which declined 31.5%, but has rallied 40% since.

China Merchants Bank was the trust’s worst performer due to its ‘property exposure, soft consumer confidence, and an unexpected change in senior management’. Technology and e-commerce stocks at the heart of regulatory tightening also sank.

The portfolio managers responded by adding defensive stocks (including consumer staples), and reduced exposure to healthcare, technology, and renewable energy.

New positions were taken in dairy products producer Inner Mongolia Yili and China’s largest cement manufacturer Anhui Conch Cement to increase exposure to infrastructure.

‘We participated in the Hong Kong IPO of China Tourism Group Duty Free,’ Yeo and Kwik said. ‘Its shares were listed at an attractive discount and we believe the company’s long-term outlook is positive.’

The fund exited construction engineering group China Conch Venture and its spin-off China Conch Environment Protection, due to ‘worsening competition dynamics and concern over the companies’ funding capability’, and divested of surgical robot company Shanghai MicroPort Medbot due to ‘increased regulatory risks that did not align with our original expectations’.

However, Beijing’s reversal of zero-Covid and reopening of the economy has sparked the managers into more positive action, arranging a revolving credit facility that provides £15m of cash to invest and a further £15m to draw down if necessary.

This can be ploughed into their five investment themes:

• Aspiration – focusing on consumer stocks that will ‘fare well as China strives for a self-sufficient economic model’ and benefit from the ‘premiumisation’ of products and services.
• Digital – aligning with the government’s objectives of ‘localisation, improving productivity, lowering costs, increasing innovation, and helping to propel economic growth’.
• Green – benefitting from the government’s decarbonisation policy and including solar wafer producers and battery manufacturers.
• Health – tying in with government efforts to make healthcare cheaper and more accessible.
• Wealth – linking to China’s objective of becoming a ‘moderately prosperous society by 2035’ with financial services set to play a key role.

While the pair were keen to play up the environmental, social and governance (ESG) credentials of the portfolio, they failed to mention accusations of human rights abuses in China. The alleged detainment of more than 1m Uyghurs, the mostly Muslim ethnic group in the north-west region of Xinjiang, for instance, has been condemned by groups such as Amnesty.

Looking ahead, Yeo and Kwik expected a ‘multi-stage recovery in China, with domestic consumption normalising, supported by excess savings among households and depressed valuations’. 

‘We believe a combination of favourable earnings and supportive policies in 2023 will help improve international investor sentiment towards China,’ they said.

Sentiment needs to improve towards the trust too. The shares stand on an 11% discount to net asset value that is larger than the 2%-9% deficits of rivals from JPMorgan (JCGI ), Baillie Gifford (BGCG ) and Fidelity (FCSS ), who provide a cheaper entry point for investors who think the worst is behind China.