China’s abrupt Covid U-turn has created the best opportunity in years for Asia and emerging market equities to outperform developed markets on a sustainable basis. It is likely to be one of the select few major economies where growth could accelerate in 2023 as China, where equity market valuations remain undemanding, enjoys a reopening recovery like much of the rest of the world witnessed in 2022.

And yet it is India that remains the best structural domestic demand story in the Asia and emerging market universe. India’s growth trajectory is forecast to outpace nearly all emerging and developed economies in 2023, with an International Monetary Fund estimate of 6.1% growth versus 5.2% for China, but investors must pay up to access this expansion, since inflows from domestic retail and institutional investors have resulted higher valuations versus other emerging markets.

Given this tantalising set-up, which of these two emerging market giants offers adventurous investors the superior risk/reward profile in 2023 and beyond? In this article, we lay out the opportunities and threats in both markets with input from investment experts who run money in these vast economies on a day-to-day basis.

CHINA 

WHY THE REOPENING EXCITES

Deeply out-of-favour with investors in recent years due to concerns around its property sector and the continuation of Xi Jinping’s draconian ‘zero-covid’ policy, stock markets cheered after the policy was relaxed in December 2022. The exit from zero-Covid after three years of strict curbs is expected to be the catalyst for a year of cyclical recovery in China, which experienced 3% GDP growth in 2022, its second lowest level of annual growth since the 1970s.

Chinese equity markets have rallied strongly since the authorities’ abrupt abandonment of zero-covid – the MSCI China index is up 50% since the trough in October last year – with support for the property sector, the pro-growth policy shift signalled at the annual Central Economic Work Conference in December and a more benign regulatory environment for large internet companies also lifting sentiment.

OPPORTUNITIES IN YEAR OF THE RABBIT

22 January officially marked Chinese New Year, the Year of the Rabbit, a symbol of longevity, peace and prosperity, and managers of dedicated China funds are full of optimism at this early stage of 2023.

Dale Nicholls, manager of Fidelity China Special Situations (FCSS), says the reversal in the zero-Covid policy has played out faster than he expected. He adds: ‘This focus on restoring confidence and reviving growth underpins an increasingly positive outlook for China.’

Singapore-based Chetan Sehgal, the lead manager of Templeton Emerging Markets Investment Trust (TEM) which invests in both China and India, expects China to follow a similar pattern of post-Covid consumption to other emerging markets.

An estimated RMB 6.6 trillion in excess savings has been built up during three years of zero-Covid policy, which should in part act as a driver, he explains, adding that Chinese purchasing power is not expected to weaken. Inflation is forecast to remain subdued in China, partially due to the decline in energy prices from their peak, a stable domestic supply of agricultural products and commodities sourced from Russia.

Sehgal argues corporate earnings should deliver, ‘eventually’, though the near-term outlook remains weak as companies struggle to scale up production and distribution in the face of the pandemic. He says the real estate sector outlook is lacklustre, and credit demand may take time to recover, which is likely to act as a drag on the financial sector. Nevertheless, he expects earnings to recover in the second half of the year as supply chain issues are addressed and the real estate sector stabilises.

Joseph Little, global chief strategist at HSBC Asset Management, expects 2023 to be a year of cyclical recovery for China with GDP growth of 5% to 5.5%, though he warns the country’s growth profile is likely to remain ‘volatile’ in the first quarter due to Covid-related disruption, ahead of ‘a boomlet of activity’ from the second quarter onwards driven by a renewed surge in consumer activity and a significant revival in tourism.

Elizabeth Kwik, co-manager of investment fund Abrdn China (ACIC), believes this could be an ‘excellent time’ to get into China as she believes the stars are aligned for a meaningful recovery in growth, driven by consumption.

Once China’s reopening benefits fully materialise in the months ahead, Kwik expects to see a drawdown of consumers’ excess savings, which she believes will benefit sectors ranging from consumer and healthcare to property and finance.

On the geopolitical front Jerry Wu, manager of Polar Capital’s China Stars Fund (BG43Q64), sees 2023 as the year of a ‘relationship reset’ with the West. China has struck a balance in handling its relationship with both Russia and the West since the Ukraine invasion, but ‘a more volatile Eurasia and closer alliance between the US and Europe is certainly not what China wants,’ explains Wu. ‘Behind closed doors China will be seeking to assure European leaders that they want a peace deal and are willing to participate in rebuilding Ukraine.’

RISKS TO CONSIDER

One risk to weigh is how infections during China’s Lunar New Year migration affect public and corporate behaviour. Adrian Lim and Pruksa Iamthongthong, managers of Asia Dragon Trust (DGN), which has 32.4% of assets in China versus 17.6% in India, believe the China reopening will be bumpy at the start with infections peaking in different phases, starting with cities before moving to rural areas. That said, they expect a multi-stage recovery ‘where domestic consumption normalisation has a long runway ahead, supported by excess savings among households.’

Carlos Hardenberg, who manages Mobius Investment Trust (MMIT) alongside legendary emerging markets investor Mark Mobius, is ‘constructive’ with regards to China’s recovery potential but warns we must be mindful and prepare for a stony path into the recovery.

Exports this year could be negatively impacted by weak demand from the EU and the US, booster rates among the elderly in China remain very low and the desire to reach herd immunisation can take time.

HSBC’s Joseph Little warns the reopening upswing in China is likely to be less pronounced than what we saw in Western economies, due to softer consumer confidence and headwinds in the services and construction sectors.

Potential headwinds identified by Kwik at Abrdn include a further escalation of US-China tensions, particularly over Taiwan. ‘This remains a lingering issue, but we do not at this point expect any sudden surprises considering the tone adopted by both countries following last November’s meeting between presidents Xi Jinping and Joe Biden,’ she explains.

INDIA 

CAN IT SUSTAIN HOT RETURNS?

India was poised for a cyclical rebound before its momentum was derailed by Covid, but the growth story is now playing out with many global companies being drawn to the opportunities its domestic economy offers.

On course to being the fastest-growing major economy in the coming years, India is one of the world’s largest consumer markets outside the US and China, underpinned by a young, dynamic population with expanding disposable income.

Also blessed with an entrepreneurial culture, bulls believe the country will benefit from increased infrastructure investments, rising digital adoption, evolving healthcare trends and its deep pool of Indian software talent.

DEMOGRAPHIC DIVIDEND EXCITES

BambuBlack Asset Management’s Jane Andrews, who runs the SVS BambuBlack Asia Ex-Japan All-Cap Fund (B5448K8), sees India’s long-term outlook as ‘very positive’, with its young population providing a demographic tailwind. ‘Gen Z and Millennials are estimated to account for over 50% of the population by 2030, and this demographic tends to have the greatest propensity to spend,’ explains Andrews.

This year, India is set to overtake China in terms of total population and given China’s ageing society, time will tell whether they can avoid the middle-income trap, she says. ‘India is also about 18 to 20 years behind China in terms of manufacturing and urbanisation, especially in the development of lower tier cities.’

Narendra Modi’s government has implemented economic and business-friendly policies in recent years, making the country more attractive to foreign investment. And US-China rivalry is providing a tailwind as manufacturers move toward a ‘China-plus-one’ strategy, establishing an additional manufacturing base outside China to mitigate against supply chain risks.

For example, Apple (AAPL:NASDAQ) is assembling its latest iPhone models in India, marking a major break from its practice of reserving much of that activity for Chinese factories run by its main Taiwanese assemblers.

Also weighing in is Swathi Seshadri of the investment team at Mobius, who points out credit growth continues to do well after a strong recovery in 2022 and domestic consumption remains stable and aids manufacturing and service-oriented companies in India. ‘Exporters have benefited from the disruption in China and depreciation of the rupee over the last year, but we remain cautious on companies that rely on US and European spending in 2023, for example, Indian IT.’

ARE INDIAN EQUITY VALUATIONS TOO SPICEY?

Templeton Emerging Market’s Sehgal says Indian equities will likely continue to outperform other emerging markets amidst expectations for continued strong economic growth. But BambuBlack’s Andrews warns the outlook this year is ‘less compelling’ as India’s valuations are stretched versus many other emerging markets, as well as their historic trading range.

In comparison, with China having ended its tech sector crackdown and relaxing restrictions on property developers, Andrews believes China’s short-term outlook is more positive with valuations looking attractive.

Ocean Dial Asset Management’s Gaurav Narain, principal adviser on the India Capital Growth Fund (IGC), informs Shares that India has had two very good years as a market and was one of the best performers last year. ‘The domestic economy is really robust, a lot of growth and capital expenditure, everything is trending well. But the big issue is valuations look very expensive relative to other emerging markets like China.’ Valuations are not very supportive, says Narain, so it is critical that India lives up to its growth story.

Self-confessed ‘India bull’ James Thom, one of the managers on Aberdeen New India Investment Trust (ANII), concedes there are headwinds for investors short term, as India’s good run means it is a natural place for global allocators to take profits. ‘That’s happening to an extent, but I think it will be a relatively short-lived rotation effect. If you’re taking a longer perspective than the next quarter or two, then I’m quite positive on the India story for this year.’

Like Andrews and Narain, Thom concedes India is expensive, but he says that’s nothing new. ‘India has always been expensive and traded at a premium to the rest of Asia. If anything, that premium has come off a little bit.’

Asia Dragon’s Lim and Iamthongthong point out India’s capital market has expanded rapidly in recent years. ‘The country is home to some of the highest quality companies in the region, with strong market positions – at home and abroad – superior return metrics, solid balance sheets, consistent growth through cycles and some of the most capable management teams anywhere in Asia.

‘This is why our Asian portfolios have consistently been overweight India despite the valuations and despite the macro highs and lows.’

The Abrdn duo argues India excels in industries such as financial services, the consumer sector and healthcare, where they hold companies including HDFC (HDFC:NSE), Maruti Suzuki (MARUTI:NSE) and Hindustan Unilever (HINDUNILVR:NSE).

While the IT services sector faces near-term challenges due to worries around a potential recession on the horizon, the Asia Dragon managers regard this as ‘an attractive segment’ in the long term, along with internet and renewables companies, where they hold names such as PB Fintech (POLICYBZR:NSE), which runs the online insurance aggregator Policybazaar.

INVESTMENT IDEAS 

GOOD WAYS TO GET EXPOSURE TO CHINA AND INDIA

For risk management reasons, retail investors should consider obtaining their exposure to China and/or India through broader Asian or global emerging market funds including investment trusts, whose closed-ended structure is well-suited to holding often illiquid emerging market stocks.

One solid selection is JPMorgan Emerging Markets (JMG), which according to the Association of Investment Companies is one of the best 10-year performers in the global emerging markets sector, having delivered a healthy share price total return of 114% over that period.

The trust, which trades at a 5.7% discount to net asset value, has ongoing charges of 0.84%, among the lowest in the sector reflecting the benefits of its scale.

Managed by seasoned emerging markets expert Austin Forey alongside John Citron, India is its biggest regional allocation at 22.5% followed by China at 21.7%, with top 10 positions including Chinese internet group Tencent (0700:HKG) and India’s Infosys (INFY:NSE), the Bangalore-based business consulting-to-information technology firm.

Investors seeking single-country exposure to China might look to the best 10-year share price total return performer in the AIC’s China/Greater China sector, namely the aforementioned Fidelity China Special Situations, up over 250% on a decade-long view and invested in the likes of Ping An Insurance (2318:HKG), e-commerce-to-internet group Alibaba (9988:HKG) and privately-owned TikTok-parent Bytedance.

Investors with a taste for the hot returns offered by India long-term might be tempted by the top-performing India Capital Growth Fund (IGC), although you’ll have to pay up for the privilege as ongoing charges of 1.5% are the highest in the AIC India sector.

For reference, the largest India investment trust in terms of assets is JPMorgan Indian (JII), currently trading on a 16.1% discount.

The trust on the widest discount, 17.9% at the time of writing, is Aberdeen New India, a quality company-focused trust which has faced a style headwind. 

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