Market Review

 

Volatility in the Chinese market, especially the A-share market continued into July. After a further down-swing at the beginning of the month, the Shanghai Composite Index climbed by over 18% in the second and third week of July. The rebound, however, was eroded by an unexpected setback towards the end of the month. This ‘aftershock’ was likely due to worries over the potential withdrawal of market-supportive government measures and a lack of confidence in the A-share market. As a result, the government clarified that Beijing’s market stabilization fund, implemented as a response to increasing volatility in June, will not be withdrawn in the near-term. Additionally, the extension of stabilizing measurements such as a reduction of transaction costs, extended financing channels for brokers ,and further monetary easing provided by the People’s Bank of China (PBOC) are intended to support a rebound of the market.

 

On the macro front, Chinese GDP growth of 7% slightly exceeded second quarter expectations. However, Caixin (formerly HSBC) Purchasing Managers’ Index (PMI) fell by 1.6 to 47.8 in July, the sharpest decline since March 2014. Overall, the economic situation remains lackluster. The negative market sentiment in China spread to the Hong Kong equity markets in July. In total, the Hang Seng Index fell by 6.2% in local terms over the month.

 

The Taiwan Stock Exchange Weighted Index continued on its downward trend, falling 9.2% in US dollar terms over July. Macroeconomic data has signaled deteriorating manufacturing conditions, including decreases in total new business and new export work, along with weaker client demand. Concurrently, deflationary pressures have intensified, with both input and output prices falling over the month.

 

Fund Review

 

July was another challenging month for Chinese equities with the Shanghai Composite Index falling 14.5%.

Portfolio activity was limited during the month and our key positioning remains unchanged. We are notably underweight in cyclical sectors such as energy and materials; and cyclical industries such as construction-related companies. Our focus remains on companies which we believe will deliver sustained growth, either because of supportive macro factors, such as the ongoing development of the services sector, or because of favorable government policy. We continue to like “policy winners”, such as renewable energy and railway equipment names which are likely to come into focus with the upcoming release of details on the thirteenth 5-year plan.

 

In this environment mid and small cap stocks have typically been hit the hardest. One example in the portfolio is Digital China, a small cap IT distribution and solutions provider. We have invested in Digital China for many years. However it has more recently become a strong performer as the company’s turnaround from an IT distributor to an IT service provider has been increasingly recognized by the broader market. Despite its recent setback, we maintain our positive view on the stock in the medium term.

 

Key Transactions

 

Our key positioning remains largely unchanged, except for our China A-share exposure. We further trimmed our China A-share positions during the month and have slightly above 5% exposure at the end of July. We rotated the proceeds into China Merchants Bank and several “policy winners,” such as renewable energy and railway equipment names, which are likely to come into focus with the upcoming release of details of the government's thirteenth 5-year plan. China Merchants Bank is the first joint-stock commercial bank in China. We like its strength in retail banking as well as its strength in small-medium enterprise operations.

 

Outlook

 

Our view on China is that we believe the sell-down has been driven primarily by forced selling of retail investors. China’s recent rally was driven mainly by leverage with many investors buying on margin for the first time. The falling market has resulted in margin calls and hence the forced selling. With many China A-shares suspended, this selling has extended to the Hong Kong market. In fact the sell down in the H Share market has been almost as great as the A share market.

 

We believe this has left many Hong Kong-listed stocks trading at very attractive valuations and, when investor confidence returns, this is the market that global investors will look to. With respect to the recent weakness in the A share market, we now see pockets of opportunity and would not be surprised if our A share exposure rises in the coming months.

 

Overall, we do not see the equity market sell down having a meaningful impact on the real economy. Few households have direct exposure to equity markets and corporate financing in China still mainly relies on the banking sector. We expect to see further monetary easing and targeted infrastructure spending in the second half of the year to stabilize the economy, which in turn would lead to confidence returning to China’s capital markets.

 

In Brief

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Fund Data

 

Description	Seeks to achieve long-term capital appreciation through investments in China companies.
Listing Date (NYSE)	July 10, 1992
Total Fund Assets (millions)	$328.7
Median Market Cap (in billions)	$6.7
Distribution Frequency	Annual
Management Firm	Allianz Global Investors U.S. LLC
Portfolio Management	Christina Chung, CFA Lead Portfolio Manager

Performance (US$ Returns) (as of 7/31/15)
	Fund	Benchmark1
One Month	-10.58%	-7.76%
Three Month	-16.66%	-13.51%
One Year	1.95%	1.24%
Three Year	12.13%	11.01%

Net Asset Value / Market Price
Net Asset Value (NAV) / Market Price at Inception	$13.15 / $14.26
NAV / Market Price (as of 7/31/15)	$20.96 / $17.75

High / Low Ranges (52-Week)
High / Low NAV	$26.04 / $19.82
High / Low Market Price	$22.46 / $17.61
Premium/Discount to NAV (as of 7/31/15)	-15.31%

Fund Data (Common Shares)
Shares Outstanding	15,682,028
Average Daily Volume	49,593
Expense Ratio	1.30%

 

Fund Manager

 

 

1. MSCI Golden Dragon Index.

 

Investment Objective

Average Annual Returns
	1 Month	3 Month	YTD	1 Year	3 Year	5 Year	10 Year	Inception
NAV	-10.58%	-16.66%	1.40%	1.95%	12.13%	6.11%	14.23%	10.72%
Market Price	-10.67%	-18.99%	-2.63%	-3.38%	9.60%	4.52%	11.38%	9.54%
MSCI Golden Dragon Index	-7.76%	-13.51%	2.77%	1.24%	11.01%	6.67%	8.49%	—

Calendar Year Returns
	2007	2008	2009	2010	2011	2012	2013	2014
NAV	86.20%	-46.95%	72.83%	27.26%	-24.37%	12.12%	18.31%	7.82%
Market Price	50.24%	-40.65%	72.19%	23.60%	-27.51%	20.52%	12.70%	5.29%
MSCI Golden Dragon Index	37.97%	-49.37%	67.12%	13.60%	-18.35%	22.65%	7.25%	8.06%

 

 

Sector Allocation
	Fund	Benchmark1
Financials	31.76%	40.93%
Information Technology	25.86%	21.55%
Industrials	12.27%	7.47%
Consumer Discretionary	10.87%	5.66%
Consumer Staples	7.41%	2.94%
Telecom Services	4.41%	7.20%
Health Care	2.76%	1.06%
Materials	0.61%	3.25%
Utilities	0.00%	5.05%
Energy	0.00%	4.54%
Other assets & liabilities	4.05%	0.00%

 

 

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Distribution History (10 Year)

 

Distribution/Share includes Income, Long-term Capital gains and Short-term Capital gains.

 

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The China Fund, Inc.

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Portfolio in Full

Source: State Street Bank and Trust Company, IDS GmbH - Analysis and Reporting Services, a subsidiary of Allianz SE.

 

Important Information:

 

Holdings are subject to change daily. The Fund seeks to achieve its objective through investment in the equity securities of companies and other entities with significant assets, investments, production activities, trading or other business interests in China or which derive a significant part of their revenue from China. Investing in non-U.S. securities entails additional risks, including political and economic risk and the risk of currency fluctuations, as well as lower liquidity. These risks, which can result in greater price volatility, will generally be enhanced in less diversified funds that concentrate investments in a particular geographic region.

 

The information contained herein has been obtained from sources believed to be reliable but Allianz Global Investors U.S. LLC and its affiliates do not warrant the information to be accurate, complete or reliable. The opinions expressed herein are subject to change at any time and without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Investors should consider the investment objectives, risks, charges and expenses of any mutual fund carefully before investing. This and other information is contained in the fund's annual and semiannual reports, proxy statement and other fund information, which may be obtained by contacting your financial advisor or visiting the fund's website at www.chinafundinc.com. This information is unaudited and is intended for informational purposes only. It is presented only to provide information on the Fund's holdings, performance and strategies. The Fund is a closed-end exchange traded management investment company. This material is presented only to provide information and is not intended for trading purposes. Closed-end funds, unlike open-end funds, are not continuously offered. After the initial public offering by a closed-end fund, its shares can be purchased and sold on the open market through a stock exchange, where shares may trade at a premium or a discount. The market price of holdings is subject to change daily.

 

P/E is a ratio of security price to earnings per share. Typically, an undervalued security is characterized by a low P/E ratio, while an overvalued security is characterized by a high P/E ratio. P/B is a ratio of the current stock price to the book value. This is used to identify undervalued stocks. Dividend yield is the annual percentage of return earned by an investor on a common or preferred stock. The average dividend yield is the dividend rate divided by current share price.

 

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