DYNAMIC ASIA PACIFIC EQUITY FUND - Benjamin Zhan, MBA, CFA, VP & Portfolio Manager

September 8, 2021

DYNAMIC ASIA PACIFIC EQUITY FUND
Benjamin Zhan, MBA, CFA, VP & Portfolio Manager

I think many of our readers would agree that the past few months have been very difficult for any investor in Asian equities,
particularly Chinese stocks. But I think many people may not have realized that what we had experienced was the biggest
correction ever for Chinese stocks listed in the U.S., bigger than the trade war and bigger than the pandemic. If history is
any guide, the biggest rewards are often born out of biggest crises, and in my opinion, this is one of those moments.

Why did things get so bad? Most people would point to the Chinese government’s recent regulatory changes amidst the
confrontations with the U.S., but those are not enough to inflict such damage. The real reason is that some Western
investors, led by George Soros, were “awakened and shocked“ by the events which unfolded over the past few weeks, and
have come to the conclusion that China has started a war against private entrepreneurship, against the free market, and
against Western political and economic systems, and as China goes backwards in its economic progress, all those large
Chinese companies’ operating models are broken. This thinking triggered a panic among Western investors, and as they
rushed to unload their Chinese stocks, Chinese ADRs listed in the U.S. and shares listed in Hong Kong experienced
disproportionate pressures.

But people like Soros are, in our view, wrong, and have missed two things: 1) the recent events were not a sudden
change, but a continuation of China’s structural transformation that began years ago and rotated across different
industries. Notable actions in the tech and media industries included those for Tencent gaming in 2018 and Ant Financial in
2020, but it has clearly reached a high note in July this year. And, 2) while many of those actions were labeled as
“crackdown” in news headlines, they are very sensible actions suited to China’s unique social and economic environment,
and they carry positive long-term implications for the healthy development of Chinese society. In reality those actions are
the Chinese government’s responses to the calling of the Chinese society, and there is no need to demonize those events
or extrapolate the implications.

Ironically, what has Soros and others concerned may well have been well received by the Chinese people and investors
inside China, and their trust in the Chinese government is on full display in the Chinese stock market, as a strong contrast
to those ADRs in the U.S.

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While many people view everything about China from the angle of ideological confrontation and political control, they fail to
understand that the Chinese government and the Chinese people have always focused on self-improvement. This time,
the government’s goal is to rebalance and enhance China’s long-term economic growth through a push towards “common
prosperity”. What is the point of “common prosperity”? People in wealthy and well-balanced economies may have a difficult
time appreciating, because, as the chart of the right below shows, income distribution in the U.S. has already formed an
ideal olive shape with middle-class families as the stable core. But in China, shown in the left chart, middle-class families
are still the minority, and well over 600 million people still in the low-income category. All it takes is a moral judgement and
some basic business sense to see that, if the Chinese government manages to move a portion of the 600 million people
towards the middle-class, it can become a huge source of self-generated economic growth.

To truly appreciate the sheer size of consumption power to be unleashed, we just need to see the massive volume of
products purchased by Chinese consumers each year against the supressed price points they are paying now. If the
rebalancing efforts successfully boost the consumption capacity of the largest group of Chinese families, our thesis of the
potent emergence of Chinese middle-class consumption will finally come to fruition.

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This has huge implications for China, but it goes far beyond China. For example, there is a widely held misconception that
the tiny group of super wealthy Chinese represent the future for European luxury goods companies, but anyone who
knows China would see that aspirational middle-class consumers are the real driving force for this industry, and as such,
what China is doing now is a major boost to the sector’s long-term growth.

In the end, it is highly questionable if people like Soros actually represent the majority of Western investment community.
As shown in the chart below, global investors have continuously shifted assets towards Chinese domestic stock markets,
with total investment jumped 5x over the past five years, despite the trade war, tech war, capital market war, and
pandemic. There has been no sign of slowdown. For the first 8 months of 2021, the total foreign inflows into Chinese A-
shares reached about RMB 177 billion, compared with RMB 200 billion for the entire 2020, a nearly 30% acceleration.

The Chinese people, along with many global investors, collectively see one thing: China is going through a major economic
transformation, and the recent actions by the Chinese government are not a step backward, but to lay the foundation for
further acceleration of this transformation. Yes, some of those actions will have negative impact on specific companies, but

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capital doesn’t simply disappear, every dollar out of one space is being injected into other areas, some of which will carry
more significant economic benefits. This is not a distraction, but a boost.

I believe the sell-off has created a great buying opportunity, and now, some encouraging signs have emerged. As shown in
the following chart, Hong Kong’s Hang Seng Index has dipped below the book at the end of August, for the fourth time over
the past 30 years. In each of the past 3 times, it marked the bottom of the selloff and heralded the beginning of a period of
strong performance in Hang Seng Index. No one can guarantee history can repeat exactly, but for investors with a long
view this is a good crisis that should not be wasted.

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