The JPMorgan China Region Fund Seeks Merger For Shareholder Returns

| About: Korea Equity (KEF)
This article is now exclusive for PRO subscribers.


The China Region Fund has been seeking ways to boost shareholder value and narrow the discount to NAV.

A newly announced merger has helped to do just that.

The discount to NAV has halved in the last few months but there is still significant upside, and a dividend, for new investors.

Earlier this year the managers of JPMorgan's China Region Fund (NYSE:JFC) announced they were actively seeking ways to enhance shareholder value, increase appeal in the fund and decrease its discount to NAV. At the time there was little indication the fund was seeking to merge with another, but that's what they are doing and the results so far are good. The deal has not yet been finalized but would merge the Korea Equity Fund (NYSE:KEF) with the JPMorgan China Region Fund to form a new entity under JFC's current management. The new fund would then be called the North East Asian Growth Fund. In terms of total assets, the merger would increase the size of JFC by nearly 65%, highlights of the proposed deal are as follows:

  • The JPMorgan China Region Fund would absorb the Korea Equity Fund. JF International Management, Inc. would remain as financial adviser. It will be renamed the North East Asian Growth Fund.

  • Following shareholder approval the fund's strategy would be modified to include South Korea and companies doing business in South Korea in addition to China, Hong Kong and Taiwan.

  • While broadening the region of investment, the investment strategy will be concentrated in order to differentiate it from other closed end funds listed on the NYSE. No mention yet of what that means. The new benchmark will be the MSCI All Country Far East Ex Japan Total Return Index.

  • Annual investment advisory fee would be 0.9%, based on managed gross assets.

  • Post merger the fund would buy back up to 50% of issued shares at NAV.

Needless to say the news was a bit of a surprise but has already helped accomplish management's goals; more attention for the fund, a narrowing of the NAV discount and higher share prices. Shares of the fund jumped more than 3% on the news and are likely to move higher should the deal continue to move forward.

The discount to NAV has narrowed by 30% since the news was released and is at a 5 year low of -7% but there is still room for it to narrow further. As of this writing it is pushing up against a 6 month high and holding steady near $17.85, a potential 8% upside from today's prices when considering management's proposed buyback plan. The KEF has also seen a dramatic narrowing of its discount to NAV. NAV has been holding near $8.60 recently, share prices near $7.95, giving a discount of -7%. This is a 5 year historic low and about half the discount offered last year.

The Korea Equity Fund is a closed end fund managed by Nomura designed for investors seeking exposure to Korea. It is focused on capital appreciation and invests in companies exhibiting signs of long term growth across a variety of sectors. As a specialized fund it is a perfect target for acquisition and will complement JFC's current portfolio. The KEF portfolio is invested 97.5% in Korean equities, mostly established large cap companies, and would add instant exposure to one of Asia's top markets, an efficient expansion that will help drive shareholder value for owners of JFC. In terms of performance, the fund has beaten its benchmark in the 1, 3 and 5 year periods.

Update On The China Region Fund

There were some changes to the portfolio in the last update from management although core positions remain unchanged. The most notable is a 6.6% increase in liquidity, a fact that management failed to comment on. Six sectors within the portfolio saw notable declines in exposure, fueling the rise in capital. Financials led with a trim of -3.8% of exposure, followed by telecoms -3.5%, materials -2.5%, utilities -2% and a -0.9% cut in both consumer staples and energy. Four sectors saw increases led by the consumer discretionary sector's 4.9%, by far the largest increase. The second largest was only a 1% increase in exposure for health care. Taiwan and China "H" shares were the hardest hit in terms of market, China "P" chips saw the biggest increase.

Looking forward managers are cautious about a rebound in China's industrial economy despite the government's efforts to support it. On the flip side they are optimistic on the consumer side of the economy where growth prospects are brighter. The refocus to consumer driven stocks is not misplaced. While industrial production remains positive the numbers continue to fall. The latest read on output shows only a 6.2% YOY increase, well below the long running average and far below the peak when it was running over 20%. Retail sales are also down from their peak but are holding above 10% and expected to remain strong into the coming years.

They also see opportunity for technical support in the coming months on the open of the Shenzen Stock Connect and possible inclusion of China in major stock indices. The risk to China is that GDP growth will continue to slow. The good news is that GDP is running a little hotter than expected, helping to alleviate fear of a "hard landing", as fiscal stimulus appears to be helping. In terms of future stimulus, little is expected but sources within and outside the government see an increase in the fiscal deficit ratio as the next possible move to boost economic activity.

The Bottom Line

The bottom line is that China remains one of the most attractive emerging, emergent, markets in the world. The country's economy continues to grow, long term outlook is positive and the China Region Fund is well positioned to take advantage of that growth. At the same time, fund managers are making bold moves to increase shareholder value, moves that are already bearing fruit. Recent improvements in the discount to NAV and share prices will likely continue to improve as the merger with the Korean Equity Fund moves forward.

Disclosure: I am/we are long JFC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.