Second Quarter 2017

The China Region Fund gained 11.60 percent in the second quarter of 2017, outperforming its benchmark, the Hang Seng Composite Index, which gained only 7.70 percent during the same period. See complete fund performance.

Past performance does not guarantee future results. Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost.

Strengths

  • Outside the benchmark's domicile of Hong Kong--from which the large majority of the fund's outperformance derives--the China Region Fund's allocation to Indonesia proved to be the most useful individual country allocation for the second quarter. Despite a slower-than-anticipated pace of growth than Joko Widodo's administration hoped, Indonesian stocks continued to perform, and our allocation among Indonesian banks and infrastructure paid off.
  • While the fund's overall allocation to consumer goods remained more or less in line with the Hang Seng's for the period in question, its stock selection within consumer goods afforded the China Region Fund its best relative sector outperformance against the index.
  • The dominant single contributor for the China Region Fund during the second quarter period of 2017 was Geely Automobile Group, which soared 42.63 percent for the quarter.

Weaknesses

  • The poorest-performing country allocation for the fund within the second quarter lay in its exposure to Taiwan. While the broader Taiwan Stock Exchange Index slightly outpaced the Hang Seng, some of the fund's Taiwanese holdings underperformed.
  • The largest detraction with respect to sector allocation in the China Region Fund for the second quarter was in properties & construction. Stock selection remained relatively poor versus the broader index performance, with a couple of underperforming Taiwanese names.
  • While China Railway Group constituted a large absolute detraction from the fund, the unfortunate title of largest relative detractor in the second quarter was tech giant Tencent, in which the fund maintained a significant but nonetheless benchmark-underweight position. Tencent climbed some 25.60 percent in the quarter, which created a headwind for the fund versus the index on that front.

Opportunities

  • Auto stocks in China had a great quarter, as evidenced by the fund's top holding--and top gainer for the quarter--Geely Automobile. Despite some dimmer views on the state of the industry and demand in China at the end of last year, as tax incentives were about to expire, 2017 has seen relatively robust demand and growth. Indeed, as Chinese economic data have come in better than expected, so too has consumer demand. In addition, Geely recently created a wave of international headlines when its Swedish subsidiary Volvo announced that it would cease production of combustion-only engines by 2019. So too Geely announced its operationally-controlling stake in Malaysian state-supported automaker Proton, which provides Geely with access to a huge network of dealers in Southeast Asia, additional production facilities--set to produce the first Geely-Proton vehicles by 2018--and the technology of Lotus, the iconic British sports car brand owned by Proton.
  • China launched its new Bond Connect program, providing international investors with more opportunity to invest in mainland Chinese debt, yet another step in China's increasing internationalization of the renminbi. Another major milestone of the quarter was the long-awaited late June announcement by MSCI of A-share inclusion in the MSCI Emerging Markets Index, which will similarly provide international investors the opportunity (indeed, to a degree, the necessity) of putting more money to work in China. This too provides a major, albeit somewhat anticipated step, in the internationalization of the renminbi.
  • China's state-owned Commercial Aircraft Corp. of China--aka "Comac"--last quarter publicized a successful test flight of its new, single-aisle, twin-engine aircraft, the 158-174 seat model C919, designed to bring eventual competition to the aerospace duopoly that is Airbus and Boeing. Though the C919 is similar in size and scale to an A320 or a 737 Max, it may yet take significant time before large-scale orders start rolling in for the China-designed product, as Comac and the C919 build a safety track record and work through kinks. According to press reports, a minimum of some 15 foreign partners worked on components and systems for the C919, an interesting mix representation of the globalized world, one in which a China-designed aircraft employed foreign components-makers' products, parts of which may themselves have been made or produced in China. The Chinese government, Bloomberg reports, has referred to the ability to build and fly a large commercial aircraft as the "flower" or "pearl" of modern manufacturing, a highly desirable--and potentially competitive or even lucrative--venture.

Threats

  • North Korea remains an ongoing--and arguably an increasing--threat. The latest series of missile launches escalated international press and concerns. North Korea, analysts say, now possesses the capability to strike as far as Hawaii or Alaska. Japan and South Korea remain particularly concerned. While North Korea represents something of a geopolitical mixed bag for China, President Xi Jinping recently announced the need to speed up the modernization of China's military given the dangerous state of things at this point. At the same time, the Trump administration has dubbed North Korea a "grave and growing" threat. Broadly speaking, North Korea and its provocations represent a clear threat. Given the delicate nature of China's situation--it shares a border with the rogue East Asian nation--investors should recognize that any one of a number of geopolitical differences between China and the U.S. (or its allies) concerning the range of options available with which to manage the North Korean situation could very well represent a potent kernel of eventual economic or market threat as well.
  • Credit ratings agency Moody's Investor Services cut China's long-term debt rating for the first time in nearly 30 years, from Aa3 to A1, and specifically cited concerns on debt levels in its outlook for the country. Indeed, worries about credit--particularly shadow banking--have fueled Xi Jinping's crackdown on leverage. Clearly, the possible tradeoff for longer-term stability could be short-term growth.
  • China's first and second quarter gross domestic product (GDP) data have impressively outperformed (admittedly lower) expectations thus far in calendar year 2017, and earnings seem to be keeping pace at this point. There remains the threat, however, that much of the year's growth is front-loaded, as most analysts have speculated, and that growth could drop off a little more sharply than expected, perhaps emboldening bears and/or frightening bulls. At the moment, though, this threat still seems distant with the Hang Seng posting new 52-week highs and the Shanghai Composite Index approaching them. But perhaps therein lies the threat.

The Hang Seng Composite Index is a market capitalization-weighted index that comprises the top 200 companies listed on Stock Exchange of Hong Kong, based on average market cap for the 12 months. The Taiwan Stock Exchange Index is a capitalization-weighted index of all listed common shares traded on the Taiwan Stock Exchange. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The Shanghai Composite Index (SSE) is an index of all stocks that trade on the Shanghai Stock Exchange.

Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the China Region Fund as a percentage of net assets as of 6/30/2017: Geely Automobile Group Co. 8.96%, China Railway Group Ltd. 2.23%, Tencent Holdings Ltd. 6.20%, Volvo Group 0.00%, Proton Holdings 0.00%, Commercial Aircraft Corp. of China Ltd. 0.00%, Airbus SE 0.00%, The Boeing Co. 0.00%.

Net Asset Value
as of 09/19/2017

Global Resources Fund PSPFX $5.83 0.02 Gold and Precious Metals Fund USERX $7.96 0.09 World Precious Minerals Fund UNWPX $6.75 0.07 China Region Fund USCOX $11.32 0.01 Emerging Europe Fund EUROX $7.02 -0.03 All American Equity Fund GBTFX $24.33 -0.04 Holmes Macro Trends Fund MEGAX $19.84 -0.13 Near-Term Tax Free Fund NEARX $2.23 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change