The ‘volatile’ fund sector rebounding sharply

China funds were the best-performing sector in November, but Saltydog Investor is unconvinced by the recovery.

It may now seem hard to believe, but when we first launched Saltydog Investor Chinese funds did not have their own Investment Association (IA) sector. The funds tended to be in the more general Asia-Pacific sectors, or you could get exposure to the Chinese markets through some of the funds in the Global Emerging Market sector.

That changed in 2011 when the China/Greater China sector was launched. The funds in this sector need to “invest at least 80% of their assets directly or indirectly in equities of the People's Republic of China, Hong Kong or Taiwan. Funds may invest solely in China or be diversified across Greater China.”

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In our weekly analysis, we currently include around 25 funds from this sector.

The sector as a whole has had a turbulent year. It started badly, falling by 4.4% in January, and although February was better it still lost a further 1.9%. It was the worst-performing sector in March, falling by 6.9%, and ended the first quarter down 12.7%.

Data source: Morningstar. Past performance is not a guide to future performance.

It made a small loss in April, but a small gain in May. In June it was the best-performing sector, rising by 10.6%.

One of the things we have noticed over the years is that the sectors that rise the quickest also tend to fall the fastest. They are the most volatile. When we compare sectors we first put them into our own Saltydog Groups based on their historic volatility. The China/Greater China sector is in our most volatile “Full Steam Ahead Emerging” group along with the Asia-Pacific sectors, Global Emerging Markets and the Technology & Technology Innovations sector.

In the third quarter, China/Greater China was the worst-performing sector, losing 14.1%, undoing all the good work it had done in quarter two. Things then went from bad to worse, and in October the sector went down by 17.2%.

Last month, we saw a dramatic rebound, with the sector making 18.3%. The top 10 performing funds in November all came from the China/Greater China sector. The best, Templeton China, rose 28.3%.

Saltydog’s Top 10 Funds - November 2022

Data source: Morningstar. Past performance is not a guide to future performance.

Even at the best of times, it is hard to know exactly why markets do what they do. It is particularly difficult in China, where the state has so much control and getting accurate information is not straightforward. The dominant force, affecting markets around the world, has been the effect of the Covid pandemic and the way in which governments have reacted. For example, the rising inflation that we are now experiencing can be linked to the massive amounts of money central banks put in to help shore up their economies during lockdown. It has been further exacerbated by reduced inventories of raw materials, disrupted supply chains and the war in Ukraine.

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The Chinese government has taken a different approach to controlling the spread of the pandemic, which started in the city of Wuhan, towards the end of 2019. It has enforced a zero-tolerance policy on outbreaks, locking down buildings, towns, cities and counties whenever cases have been detected. To start with, it appeared to be working and the reported number of deaths were low when compared with other countries. However, China has struggled with newer and more transmissible variants, such as Omicron. Unfortunately, its vaccine roll-out has not been as effective as in other countries, especially among the elderly, with millions of people refusing the jab. The lockdown policy has also had dramatic consequences on the economy with large areas being unproductive for lengthy periods.

The Chinese government has now begun to unwind its zero-Covid controls. Although it has kept some restrictions, it has reduced mass testing, stopped the health code tracking in most public places, and will now let people quarantine at home. It is hoped that industrial lockdowns will be reduced and that the domestic economy will start heading back to pre-pandemic levels. The main concern is that another major outbreak could force an about-turn.

If all goes well, the funds investing in China could continue on their current trajectory, but there are plenty of things that could go wrong. We know that these funds are volatile, and I do not see that changing any time soon.

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