East Capital China

In Q3 2026, China's equity market corrected amid higher volatility, driven by ongoing geopolitical tensions in the Middle East, shifting expectations regarding Fed policy and a period of valuation digestion in the technology sector. The technology and AI supply chains that had led the market earlier in the year saw earnings forecast revisions and valuation normalisation, which were the main sources of volatility during the quarter.

The MSCI China All-Shares Index fell by 2.8% in USD terms during the quarter, while our China fund declined 15.4%, representing an underperformance of 12.6%. This shortfall was mainly driven by the valuation correction across the AI value chain. Although we had identified stretched valuations in the technology sector and begun trimming in June, the faster-than-expected, sector-wide retreat eroded a significant part of our quarterly alpha.

Domestically, policy focused on the Political Bureau meeting and the release of the detailed implementation rules under the 15th Five-Year Plan. Support for advanced manufacturing, technological innovation and industrial self-reliance continued, with targeted fiscal incentives, major project launches and industrial guidelines being rolled out during the quarter. Although measures to boost consumption and domestic demand remained in place, household consumption recovered slowly and overall domestic demand stayed soft.

Externally, global markets were mainly disrupted by the conflict in the Middle East and a marked shift in expectations regarding US monetary policy. Repeated escalations pushed up energy prices and kept global inflation sticky. Expectations of Fed rate cuts cooled steadily, occasionally giving way to speculation about rate hikes. This supported a stronger US dollar and prompted short-term capital outflows from emerging markets. Meanwhile, the global AI industry entered a period of adjustment as overseas technology leaders slowed capital expenditure plans and lowered their forecasts for AI hardware demand. This weighed on valuations across the global technology supply chain, including China's technology and semiconductor sectors.

From a portfolio perspective, we identified signs of divergence between valuations and fundamentals within the technology sector, acting accordingly. Starting in June, we reduced our aggregate exposure to AI-related sectors, including materials, information technology and industrials, from 60% to 30%. This is below the index weighting of around 36%. Although the correction eroded part of the alpha previously generated by these holdings, they remain the largest contributor to alpha year to date, at around 8%. In parallel, we increased our allocation to healthcare, financials and undervalued, high-quality consumer stocks with prospects for an earnings recovery. All three sectors delivered positive returns in Q3, offsetting most of the negative alpha from technology.

Among our holdings, TCL Electronics was the largest positive contributor during the quarter. Its share price rose 35%, contributing 58 bps to the portfolio’s performance. This outperformance was driven by three factors. Firstly, the penetration of AI terminals accelerated, with global shipments of AI TVs and smart home products exceeding expectations, while AI-enabled upgrades increased profitability. Secondly, the panel cycle bottomed out and rebounded, stabilising prices, which allowed the company to benefit from its integrated industrial chain while easing cost pressures. Thirdly, global expansion increased market share in emerging markets, raising overseas revenue and reducing exposure to domestic demand volatility. Given its integrated supply chain, global operations and strong earnings visibility, and with AI terminal adoption still in an upward cycle, we continue to hold it as a core position.

Looking ahead to the remainder of 2026, we expect market performance to be driven by four factors: the pace at which the 15th Five-Year Plan is implemented, the earnings recovery in the technology sector, the direction of Fed policy and geopolitical developments. Policy support for industrial upgrading and technological innovation remains intact. Following the Q3 digestion, valuation excesses in the technology sector have eased considerably and earnings delivery should become the main driver of performance, allowing high-quality companies to stand out. However, risks remain, including a more hawkish Fed, which could strengthen the US dollar and increase outflows from emerging market; further escalation in the Middle East, which could reignite inflation and volatility; a continued slowdown in global AI investment, which could limit the recovery in technology valuations; and weaker-than-expected domestic demand, which could delay corporate earnings recovery.

Overall, China's equity market corrected in Q3 amid geopolitical disturbances and a pullback in the technology sector, which weakened investor risk appetite. Although the portfolio was affected, repositioning during the quarter helped to mitigate the decline. AI-related holdings remain the main source of excess return year to date, contributing around 8% of alpha. Based on league table reviews of comparable China-invested products, the fund continues to outperform its peers. The long-term logic of industrial upgrading and technological innovation remains unchanged, and we expect the technology sector will revert to a fundamentals-driven trend. We remain committed to our value-growth framework, focusing on high-quality leaders while maintaining strict risk discipline.

Performance in USD net of fees.

The information in this document should not be considered investment advice and should not be used as the sole basis for an investment decision. Please read the Prospectus and the KID, which are available on the fund page. This publication is not directed at you if we are prohibited by any law in any jurisdiction from making this information available to you and is not intended for any use that would be contrary to local laws or regulations. Every effort has been made to ensure the accuracy of the information, but it may be based on unaudited or unverified figures or sources.