Chinese stocks experienced an unprecedented rally in the final week of Q3. A series of unexpected stimulus measures pushed Chinese equities to their largest weekly rise in 15 years, supporting the outperformance of emerging markets compared to developed markets over the past three months.
Emerging markets had an excellent third quarter. The Morningstar EM TME Index gained 4.2 percent, outperforming the global equity benchmark, the Morningstar Global TME Index, by roughly 2 percentage points. This extended the positive momentum from Q2, though it has not entirely made up for the losses incurred in Q1. Over the first nine months of 2024, emerging markets posted a gain of 15.4 percent, compared to 17.4 percent for global equities.
Asian countries led the charge, with double-digit gains for Thailand, Hong Kong, the Philippines, Malaysia, and Singapore. However, these markets are generally lightweights within the Morningstar EM TME Index. It was China that took the lead, experiencing a long-awaited recovery after years of underperformance.
The Morningstar China TME Index surged by 18.3 percent in Q3, with most of the gains occurring in a very short period. Until the last week of September, the index was up by just 1 percent for the quarter, but Chinese equities soared by over 17 percent in the final week, marking their largest weekly rise since 2009.
Underweight funds in China
The sharp and sudden rise in Chinese equities was driven by a series of surprising stimulus measures from China. These included broad cuts to interest rates, mortgage rates, and banks’ reserve requirements, along with a promise of additional fiscal support from the central government to stabilise the struggling property sector.
While this isn’t the first time the Chinese government has stepped in to reignite the economy, market participants are more optimistic this time, as the measures appear more coordinated. The stimulus package is more focused on boosting consumer spending and stabilising the ailing property sector.
Investors welcomed the package, as evidenced by the strong performance of Chinese stocks following the announcement. However, few investors in emerging markets equity funds will have fully benefited. On average, funds in the Morningstar Global Emerging Markets Equity category have a 22.1 percent weighting in Chinese equities, compared to the 25.9 percent allocation in the Morningstar EM TME Index. As a result, these funds are underweight in China and have missed out on part of the recent rally.
Pzena
The strategies that stand out on Morningstar’s radar typically feature a solid management team and robust investment process, according to the qualitative assessment of fund analysts. Alternatively, they are flagged by an algorithm that evaluates funds using the same framework as the analysts. In this edition, we highlight a fund that meets all these criteria: Pzena Emerging Markets Focused Value, which receives an Above Average rating from Morningstar analysts on both the People and Process Pillars, earning a Bronze Morningstar Medalist Rating.
Pzena, a US-based asset manager, specialises in value investing and applies its proven philosophy across all its funds. Pzena Emerging Markets Focused Value is part of this range and follows a deep value approach, where the universe is filtered initially by the price-to-normalised earnings ratio. Only the cheapest 20 percent of stocks undergo a two-week initial review.
Stocks that are underperforming relative to their historical earnings and have the potential for recovery are then thoroughly researched by the firm’s stable team of 29 analysts and managers. Only stocks for which all managers unanimously agree on normalised earnings estimates and the bottom-up research findings are included in the portfolio.
Caroline Cai, Allison Fisch, Rakesh Bordia, and Akhil Subramanian form an experienced management team for this fund. Cai and Fisch are veterans, having joined Pzena in 2004 and 2001, respectively, and both have been involved in managing this fund from its inception. Bordia joined in 2007 and became a co-manager in April 2015, while Subramanian, an emerging talent within the team, was added as a co-manager in January 2023 after joining the firm in 2017.
As of the end of August 2024, the managers allocated 28 percent of the portfolio to Chinese stocks, compared to 22 percent for the category average. This includes top 10 positions in Alibaba, China Overseas Land & Investment, Tencent, and WH Group. This positioning has contributed to the fund’s 17.65 percent return over the first nine months of 2024, outperforming the category average of 14.5 percent and the 15.4 percent gain of the Morningstar EM TME Index.
Ronald van Genderen is a senior manager research analyst at Morningstar. Morningstar analyses and rates investment funds based on quantitative and qualitative research. Morningstar is part of the expert panel of Investment Officer.