China growth to slow

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The Chinese economy is now dealing with the legacy of a decade of credit-fuelled infrastructure development, which leaves it with an enormous debt burden and substantial amounts of misallocated capital. Going forward, this legacy will, in our view, result in much lower growth and a much more difficult domestic economic agenda.

From the ‘Minsky moment’ comments made by China’s central bank governor, through to the cancellation of several massive infrastructure projects and the crackdown on shadow banking, there have been a number of tangible signals to suggest that the Chinese authorities are no longer prepared to ignore the economic risks that have accompanied several years of unbridled credit expansion.

Against a backdrop of rising trade tensions, the economic implications of this are clearly not positive for China, nor for the rest of the world. Over the last twelve months, we’ve seen a decline in fixed asset investment growth, a Chinese stock market move into bear market territory and the lowest level of money supply growth since records began in 1996.

Although policy has been loosened slightly in response, Chinese policymakers seem to have acknowledged that they no longer have the firepower to sustain an artificially high growth rate supported by excessive credit expansion. China’s leadership is intent on reducing debt as part of its longer-term objectives, but one thing is clear from economic and financial history – there is no such thing as a painless deleveraging.

Whichever way China turns now, looks likely to result in either intentional or inadvertent renminbi weakness, which will consequently turn a domestic deflationary problem into a global phenomenon.

Neil's view

An interesting article in the FT today, highlighting the extent of stimulus in China, increasing evidence of policy change and widespread complacency about global growth
20 February 2018

More worrying signs about data integrity and growth in China

Read full article12 January 2018

The winds of change in China also threaten the consensus view that the outlook for global growth is benign and almost trouble free. There was a conspicuous absence of an economic growth target in Xi Xinping’s opening congress address and the remarks made by China’s central bank governor about an approaching ‘Minsky moment’ for a Chinese banking system that has been creating credit at an alarming and increasingly ineffective rate for years are also important. Meanwhile, a number of billion-dollar infrastructure projects have been cancelled and initiatives to tighten Chinese financial regulation have been introduced. All of this points to the inevitability of slower growth from the Chinese economy as it faces up to its massive bad debt problem and exports deflation to the rest of the world via its currency.

Read full blog21 December 2017

The die has already been cast by the credit explosion. It will all be about how Chinese policymakers will manage the downside. But there is no such thing as a painless deleveraging.

Read full article1 November 2017

Joining all the dots here, we are concerned that rampant Chinese credit growth has leaked into commodity markets through some inappropriate infrastructure investment and unprecedented amounts of financial speculation. This has inflated commodity prices to levels that are not justified by fundamentals. This represents a gigantic misallocation of capital and we know from centuries of economic history that episodes like this do not end well. This is why we say that the Chinese credit growth theme that has played out in markets carries considerable risk. We are not prepared to take these risks with our investors’ capital – nor do we believe that we need to in order to deliver attractive long-term returns.

Read full blog15 September 2017

The unsustainable debt burden in China represents a considerable risk

Source: Minack Advisors, Woodford

With the Chinese economy showing signs of a slowdown, the unsustainable debt burden represents a considerable risk. Equity markets have appeared complacent to these risks but we have positioned the funds with them firmly in mind.

Slower credit expansion does not bode well for China's economic activity next year

Source: Capital Economics, Woodford

China’s rapid debt growth by sector

Source: MacroStrategy, Woodford

Chinese money supply growth already slowing

Source: Bloomberg, Woodford

Estimated extent of bad debt problem as % of GDP

Source: MacroStrategy, Woodford

China's Staggering Demand For Commodities

More than half of the world's steel, cement, coal and copper is consumed by China.

Cement

59%

Aluminium

47%

Nickel

56%

Coal

50%

Population

19%

Copper

50%

Steel

50%

Gold

27%

Oil

14%

Economy (GDP)

15%

Rice

31%

Pork

47%

Corn

23%

Cotton

33%

Source and inspiration: Visual Capitalist

How the funds will benefit

The most obvious route back into financial markets here is via a lower contribution to global growth from China and indeed Asia more broadly. This is not priced in. A further market impact should arrive through commodity prices, which will not greet the absence of demand growth from China favourably. Indeed, if the Chinese authorities crack down further on regulation to curb financial speculation on commodities, amongst other things, then the impact on commodity prices could be significant.

The funds have actively avoided exposure to parts of the market that are vulnerable to the slowdown that we expect to see in the Chinese economy.

LF Woodford Equity Income Fund (as at 28 February 2019)

Geographical allocation
Country Fund (%)
United Kingdom 86.47
United States 11.40
Norway 1.07
Ireland 0.91
Switzerland 0.65
Luxembourg 0.48
Sector allocation
Industry Fund (%) Benchmark (%)
Financials 37.84 26.34
Consumer Goods 22.19 13.91
Health Care 21.72 8.23
Industrials 13.24 11.23
Technology 5.09 1.10
Consumer Services 0.86 11.65
Basic Materials 0.06 8.05
Utilities 0.00 2.86
Telecommuncations 0.00 2.59
Oil & Gas 0.00 14.04
Cash and near cash -0.99 0.00
Total 100.00 100.00

What are the risks?

  • The value of investments and any income from them may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The annual management charge is charged to capital, so the income of the funds may be higher but capital growth may be restricted or capital may be eroded
  • The funds may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits – some of these security types could increase the funds’ volatility and increase the level of indirect charges to which the funds are exposed
  • The funds and trust may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the sterling value of these investments and the income from them, to fluctuate
  • The LF Woodford Income Focus Fund will be invested in a concentrated portfolio of securities – the fund is not restricted by reference to any geographical region, sector or market capitalisation
  • The LF Woodford Equity Income Fund and the Woodford Patient Capital Trust may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value
  • The price of shares in the Woodford Patient Capital Trust is determined by market supply and demand, and this may be different to the net asset value of the trust. This means the price may be volatile in response to changes in demand
  • Long-term outcomes are more binary – extremely attractive rewards for success but some businesses will inevitably fail to fulfil their potential and this may expose investors to the risk of capital losses
  • Young businesses have a different risk profile to mature blue-chip companies – risks are much more stock-specific, which implies a lower correlation with equity markets and the wider economy – it can take years for young businesses to fulfil their potential, this investment requires patience

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund – or Key Information Document (KID) for the trust – and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

The Woodford Patient Capital Trust currently intends to conduct its affairs so that its securities can be recommended by IFAs to ordinary retail investors in accordance with the FCA’s rules in relation to non-mainstream investment products and intends to continue to do so for the foreseeable future. The securities are excluded from the FCA’s restrictions which apply to non-mainstream investment products because they are shares in an investment trust.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund’s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

 

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

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