China growth to slow

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There is growing evidence to suggest that, with Xi Xinping having consolidated his power base at the Communist Party Congress last year, the priorities of the Chinese authorities going forward will be profoundly different to the ‘growth at all costs’ mantra of the last decade.

From the ‘Minsky moment’ comments made by China’s central bank governor, through to the cancellation of several massive infrastructure projects, 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.

This year we’ve already seen a surge of corporate bond defaults, demonstrating that these risks are starting to surface. Although monetary policy has been loosened slightly in response (for example the People’s Bank of China reduced the reserve ratio requirement for banks so they can lend out a higher proportion of their deposits), Chinese policymakers 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.

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. Already, we’ve seen indications of a Chinese economy slowdown, such as disappointing trade data, a decline in fixed asset investment and the lowest level of money supply growth since records began in 1996.

Consequently, we believe we’ll see progressively slower growth from China in the months and years ahead, as the country faces up to its massive bad debt problem and exports deflation to the rest of the world via its currency.

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.

China's credit fuelled economy set to continue to slow, more so than official figures would suggest

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 30 September 2018)

Geographical allocation
Country Fund (%)
United Kingdom 88.38
United States 9.78
Norway 1.77
Ireland 0.66
Switzerland 0.55
Luxembourg 0.40
Sector allocation
Industry Fund (%) Benchmark (%)
Financials 34.31 25.73
Health Care 22.46 9.11
Consumer Goods 22.27 14.30
Industrials 15.95 11.32
Technology 4.94 0.88
Consumer Services 1.56 11.62
Basic Materials 0.05 7.66
Telecommunications 0.00 2.95
Oil & Gas 0.00 13.91
Utilities 0.00 2.52
Cash and near cash -1.54 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 applicable to the funds 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
  • The funds may invest in overseas securities and be exposed to currencies other than pound sterling
  • 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 may invest in unquoted securities, which may be less liquid and more difficult to realise than publicly traded securities

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.

You should note that capital is at risk with these investments and you may get back less than you invested. The value of the fund or trust as well as any income paid will fluctuate which may partly be the result of exchange rate changes.

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.

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.

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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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