China is “more of an enemy than an ally” and poses too much political risk to warrant investment, according to the Jupiter Asian Income manager.
As the largest economy in the region, it is rare to find an Asian fund that does not have exposure to China, but Jason Pidcockmanager of the Jupiter Asian Income fund, reduced its allocation to zero.
Political risk has been a major concern for many investors since the Chinese government began implementing tough policies as part of its shared prosperity agenda, but heightened tensions with Taiwan have been the final straw. for Pidcock.
Its £1bn Jupiter Asian Income portfolio has grown 105.5% since its launch in 2016 and it has continued to climb 6% in 2022, while most of its Asia-Pacific AI peers outside Japan struggled to achieve a positive return.
Total return of the fund in 2022
Source: FE Analytics
Here, Pidcock tells Trustnet why he ditched Asia’s largest economy and how heightened political risk could impact the wider global market.
What is Jupiter Asian Income’s investment process?
I have been investing in Asia for 29 years now and have always had a fondness for companies that have the ability to pay decent dividends. I think being able to share your profits with your owners is an important part of being a publicly traded company.
The fund must always return at least 20% more than the benchmark index and we have always been comfortably above the minimum requirements. Today, the fund is yielding around 4.3%.
We only have 26 titles in the portfolio today, whereas there would normally be around 30.
I don’t feel like I have to fill the portfolio with lots and lots of stocks. Nothing is held simply because it is a material constituent of the index.
In fact, anything we own will almost certainly be overweight relative to the benchmark. I only have one stock today in the portfolio where I am slightly underweight and that is TSMC.
Why is TSMC your only underweight position?
It’s a great business. I don’t expect this to be my best performance, but over time I absolutely believe this is a long-term outperformance and has a place in the portfolio.
But there are other tech companies that I prefer that are cheaper, have much higher dividend yields and large net cash positions, like Hon Hai.
I have about 4.5% in TSMC so it would mean a big change if I didn’t have it. The wallet would feel a bit bare without it.
What prompted you to reduce your exposure to China in July?
I got to a point where I was too uncomfortable investing in China because politically I think it has become more of an enemy country than an ally.
My personal view is that they won’t risk trying to invade Taiwan knowing that so many other countries don’t want that to happen – it wouldn’t just be the end of Xi’s presidency, it t is probably the end of the communist era. Party rule in China.
Attacking Taiwan would send the economy into a tailspin, and it would quickly enter a deep recession. Money managers would try to get their money out of China as quickly as possible, and we’ve seen the playbook with how quickly Russia was ostracized.
There are so many other countries in Asia that are exciting and have democracies, so my point is, why should I bother taking all these risks in China when I can invest in these other countries? »
Of course, you can’t help but indirectly expose yourself to the Chinese economy, whether you like it or not, and that’s not just the case for Asian fund managers. All global equity managers have exposure to China because it’s such a big part of the global economy.
Have you seen many companies trying to get out of their dependence on China?
The U.S. government is incentivizing chipmakers to expand capacity in the United States through grants and loans on the condition that they don’t invest in China.
Samsung Electronics has to make a choice and it will no doubt be the United States. Again, for companies like TSMC, it’s clear from their meeting with Nancy Pelosi that they’re going to favor the US over China.
China has a lot of trade relations, but it doesn’t have many close political allies, so it would be easier to isolate yourself politically than many think, because it’s not just about the size of your economy.
Since China is the world’s largest manufacturer, would it be easy to reduce dependence on it?
It certainly won’t be easy, so the sooner we get to it, the better. We certainly don’t want to wait until after the event like we did with Russia.
If Taiwan were attacked, it would cause a massive global recession as it would suppress TSMC’s production. This would probably cause bigger problems than the diversion of Russian gas.
The process is started but it will take a long time. These factories take a long time to build and you need to have all the connecting infrastructure.
Over time, this slowly becomes a diminishing threat from a supply chain perspective, as long as they don’t invade between the next 18 months to two years.
Taiwan is your second biggest regional exposure – how have tensions affected your belief there?
A little, but not too much because the risk is well known and it is already capping valuations in Taiwan. If that risk suddenly evaporated, you’d expect to see Taiwanese stocks skyrocketing because there’s this discount that’s been there for a number of years already.
Whether [an attack] happened, Taiwanese stock prices would drop significantly, but so would Chinese stocks. They would fall all over the world and Chinese stocks would likely fall the hardest hit, just like we saw with Russia.
In absolute terms, my fund would decline like all Asian funds, but I would expect to outperform as my slight overweight in Taiwan is massively offset by my huge underweight in China.
What has been your best stock selection over the past year?
I would say our best was ITC, which is a tobacco company in India. Although cigarettes remain the main source of income, it is a low growth part of their business, but it is an excellent cash generator.
This allowed them to expand into other areas such as food and beverages and they are now one of the biggest companies in India. Now that they have such a large net cash balance, they are able to make many acquisitions and plug them into their nationwide distribution network.
Their earnings have gone up, their dividends have gone up, they have a rock-solid balance sheet, but they’re very cheap compared to other consumer stocks.
ITC share price since the beginning of the year
Source: Google Finance