Back in the summer of 2021, we suggested the Chinese government’s clampdown on technology companies and its deeper involvement in the private sector – which it accused of having been ‘hijacked by capital’ – risked causing an exodus of foreign investment. 

We also put forward a list of Asia-Pacific investment companies with low exposure to China, so investors could reduce their risk but still keep their money in the region and benefit from the big demographic and structural changes in chain, such as the emergence of a new, moneyed middle class and the increased use of mobile technology, especially in financial services. 

Since then, sentiment towards the world’s second largest economy has continued to sour with the market losing more than $6 trillion in value as investors have fled while Beijing struggles to revive its economy and deal with a crisis in its property sector.

To put that in perspective, US stocks have gained more than $5 trillion in value since the summer of 2021, meaning their market cap is now $38 trillion bigger than that of the Chinese and Hong Kong markets put together, a new all-time record according to Bloomberg.

CONFIDENCE IS KEY

The Chinese authorities tried to restore investor confidence last month with a reduction in the RRR (reserve ratio requirement) for domestic banks, which is meant to encourage them to lend more, as well as the introduction of a ban on short selling of stocks.

At the start of this month the country’s vice-premier called for ‘more forceful and effective measures to stabilise markets’, yet foreign investors remain wary with the Financial Times reporting that more than 40% of those attending a recent Goldman Sachs conference in Hong Kong describing China as ‘uninvestable’.

Goldman’s chief equity strategist for Asia-Pacific, Timothy Moe, was reported as confirmed investors’ aversion, saying ‘the global investors we spoke to are by and large out of China’.

There is no question valuations for many Chinese companies are now at rock bottom, but valuations in and of themselves aren’t enough of a reason to buy.

Reports last week that China’s sovereign wealth fund would step up share purchases in an attempt to put a ‘floor’ under sliding share prices did prompt a short, sharp rally, but for investors to see the market as anything more than a quick trade they need to see a change in the fundamentals.

So, as we enter the Year of the Dragon – which is traditionally seen as auspicious, bringing with it change and opportunity – we asked a group of Asian investment experts what they thought of China as an investment proposition. 

MIXED VIEWS AMONG GLOBAL EMERGING MARKET MANAGERS

For our article we polled managers of global emerging markets funds and trusts, where the MSCI benchmark gives China a 26.5% weight, and managers of Asia-Pacific funds and trusts, where the MSCI benchmark gives the country a 30.7% weighting.

Judging by their exposure, which in each instance we have taken from their latest fund factsheets, most global emerging markets managers are still reasonably positive on China, although for many it isn’t their top choice.

Instead, India seems to be the most popular country, followed for the most part by Taiwan, Korea and Brazil, while at a stock level the most popular three holdings by far are Taiwanese chipmaker TSMC (2330:TPE), Korean electronics giant Samsung (005930:KRX) and Indian financial firm HDFC Bank(HDFCBANK:NSE).

Big Chinese companies such as multimedia firm Tencent (700:HKG) and ecommerce group Alibaba (9988:HKG) tend to be some way down the pecking order for most managers.

UNDERESTIMATING IMPACT OF PRO-GROWTH STANCE

Omar Negyal, manager of the JPMorgan Global Emerging Markets Income Trust (JEMI), has a neutral weighting in China, although it still represents his biggest country exposure.

‘Although China’s near-term growth is less vigorous than before the pandemic, we think its GDP (gross domestic product) is likely to grow more rapidly than most developed economies. We also believe investors are underestimating the impact from the Chinese authorities’ pro-growth stance,’ says Negyal.

‘Taking a long-term view, China is well-positioned to maintain its role as an important positive driver of activity and markets within Asia and further afield,’ he adds.

John Citron, manager of the larger JPMorgan Emerging Markets Fund (JMG), is neutrally weighted on China but sees upside for stocks this year.

‘We believe China is focused on a sustainable growth trajectory, including removing tail risks from the real-estate sector. We also think Chinese consumption should gradually recover over the coming year which, in turn, is supportive for earnings.

‘China’s economy continues to grow, though slower than expected. Valuations – currently around their long-term averages – are reasonable, and emerging market earnings offer upside potential.’

Templeton Emerging Markets (TEM) is both one of the largest and oldest trusts in the global sector and lead manager Chetan Sehgal also has an in-line weighting in the Chinese market.

‘China has remained the only major emerging market which has disappointed, it’s been a drag on the overall index for several years. We hoped 2023 would see the country recover, but it does face some long-term challenges.

‘While government policy has become more supportive, more substantive policies and a rebound in consumer activity is required for a sustained improvement in Chinese equities. We do still see some upside in China; in particular the internet sector which has adjusted to the new operating environment as China has eased its regulatory crackdown on the sector. We expect future returns for the sector to be driven more by steady cash flow generation and corporate actions.’

Seghal believes Chinese stocks could benefit from a renaissance of interest from local investors as well as foreign money.

‘The locals remain cash-rich following the pandemic, they have the savings, assets in China are currently looking reasonable and cheap, and we’ve witnessed companies buying back shares. China has a good chance of returning to higher EPS (earnings per share) growth this year, which in turn means good prospects of returning to positive returns on an absolute basis.’

The trust recently added to its holding in Tencent after its shares had declined on new draft rules for video games which have since been abandoned.

BEARISH ON CHINA

In contrast, Mobius Investment Trust (MMIT) manager Carlos von Hardenberg is extremely underweight China with just 3.7% exposure due to lack of transparency and regulatory risks.

‘Ongoing challenges such as the authorities’ intervention in the economy, coupled with lower corporate governance standards among Chinese companies compared to their Asian EM counterparts, have steered us away from direct investment in China.

‘We rarely find the level of governance, fundamental quality and innovation that would meet our investment criteria. Instead, we prefer to access the Chinese market indirectly through countries such as Taiwan and South Korea.’

For example, the portfolio includes Elite Material (2383:TPE), a Taiwanese company specialising in components for the semiconductor industry. The company operates manufacturing facilities across China and generates a significant proportion of its revenues in the country while offering Taiwanese standards of governance and transparency, says von Hardenberg.

The manager admits investors can’t afford to ignore the world’s second largest economy, and he continues to scour the market for exciting companies that meet his quality investment criteria, but he doesn’t see a quick fix to the country’s troubles.

‘Structural challenges such as problems in the property sector, overcapacity, slowing FDI (foreign direct investment) flows and weak consumer sentiment, with around 70% of household wealth tied up in property, are weighing on investor sentiment.’ 

REGIONAL MANAGERS ARE DIVIDED

Yoojeong Oh, manager of the abrdn Asian Income Fund (AAIF), is heavily underweight China and shares similar concerns to von Hardenberg.

‘First, the market is dominated by large internet companies which don’t pay dividends; and second, many of the high-yielding names are state-owned enterprises, in sectors such as banking and utilities, and the team is finding similar high-yielding companies with better transparency and governance structures elsewhere in the Asia Pacific region.’

While she expects to remain underweight, the manager accepts there is ‘a disconnect between market sentiment, as seen in valuations and headlines, versus the economic reality on the ground’.

‘With much of the negative headlines in China already priced in, a period of calm followed by some positive news could open the possibility of a market bounce,’ admits Oh.

OPPORTUNITIES TO BE FOUND

Doug Ledingham, manager of Pacific Assets Trust (PAC), is underweight the market but believes there are opportunities for those who take a bottom-up view.

‘The trust now owns nine Chinese companies: each has a private entrepreneur, family or steward behind it who we trust to continue their track record of treating minority investors fairly while building unique and enduring franchises,’ says the manager.

He adds the following caveat, however: ‘If we were to see a deterioration in the industries in which our companies operate, greater political involvement or stretched valuations there should be no surprise if the trust’s exposure to China were to fall again.’

Henderson Far East Income (HFEL) has less than half the index weighting in Chinese stocks, but manager Sat Duhra acknowledges that despite being underweight the market for some time the trust’s exposure did it no favours last year.

‘Household debt has been increasing very sharply over the past ten years. So, people talk of savings rates being high but you also have to look at mortgages and other consumer debt such as auto-loans. Generally, 60% of household assets in China are held in property so with the recent collapse in property prices we have not really seen any return in spending.

‘Another concern we have is to do with local governments, whose indebtedness has increased year after year but their fiscal revenue has collapsed because no one is buying land from them. Property developers are in a tight spot, yet 40% of local government income lies with land sales.’

Duhra’s direct exposure is concentrated in infrastructure, technology (although not e-commerce companies) and what he calls domestic consumer champions.

The rest of his exposure is indirect, through Australian miners, high-quality Hong Kong stocks and Taiwanese tech firms which have both Chinese and global growth potential.

Pruksa lamthongthong, manager of Asia Dragon Trust (DGN), has an in-line weighting in China and believes a recovery is overdue.

‘Chinese stock markets have just come off an extremely tough 2023 and are now among the cheapest markets across the world.

‘We are still seeing weakness persist in mainland markets, but encouragingly fundamentals remain intact and we are expecting high single-digit earnings growth for the entire market. This, along with depressed valuations, lays the ground well for an eventual recovery, as the benefits of monetary and fiscal stimulus gain traction in 2024.’ 

The Schroder AsiaPacific Fund (SDP) is underweight China in terms of direct exposure, but manager Abbas Barkhordar says that over the past year ‘the opportunity set has really widened for us’.

‘If you take the Chinese market as a whole, there isn’t enough focus on return on investment or on shareholders, so when companies talk about growth it rarely feeds through to the bottom line, which is why many investors struggle.

‘Companies which do generate high returns and look after shareholders used to be highly-rated, but in the last year they have become much more affordable so with selective stock-picking it’s now possible to capture those returns.’

FOCUSED ON LONG-TERM POTENTIAL

Rob Lloyd, portfolio manager of JPMorgan Asia Growth & Income (JAGI), is also positive on the market with 37% of his portfolio in Chinese and Hong Kong stocks and a top three holding in Tencent (700:HK).

‘The Chinese economy is expected to grow around 4% this year, an enviable pace compared to western economies. China’s longer-term outlook is also positive given Asia’s structural and societal changes. For example, rising incomes, urbanisation, infrastructure investment and digitalisation,’ he offers.

Fiona Yang, manager of Invesco Asia Trust (IAT), is equally bullish and is also overweight mainland Chinese stocks.

‘We are overweight China across the portfolios within the Asia and emerging markets equities team for two reasons: the valuations on offer are compelling, and expectations are undemanding at the stock level, meaning that the odds of beating consensus are higher than for example in the Indian market.

‘Our contrarian mindset leads us to be overweight China and underweight India, without relying on big macro calls as this positioning is backed by company analysis.’  

WHAT DO COUNTRY SPECIALISTS THINK?

Rebecca Jiang, portfolio manager of JPMorgan China Growth & Income (JCGI), sees significant potential in the Chinese equity market and believes most of the widely discussed negative news has been priced in.

‘We remain optimistic about China’s long-term prospects and the opportunities that will benefit patient investors. We are encouraged by recent shifts in government policies, designed to promote economic growth and boost consumer confidence.

‘We are also finding attractive investment opportunities provided by companies that offer superior earnings growth or are benefitting shareholders by introducing regular dividends’, says Jiang.

'THE WORST IS OVER'

Investment trust Fidelity China Special Situations (FCSS), one of the ‘big beasts’ among the country specialists, is itself in a special situation this year after agreeing to take over abrdn China Investment Company (ACIC), with Dale Nicholls continuing as the portfolio manager.

Nicholls believes there are better times to come for investors: ‘Unlike Europe or the US, inflation has not been a problem in China and the government is taking measures to stimulate investment and consumption to support the post-Covid recovery.

‘Consumer confidence remains soft, mainly due to a weakened property market, but the government is addressing this by implementing various measures including lower mortgage requirements and support for property developers.’

Nicholls also notes  Chinese households have accumulated substantial savings, which sets the stage for an upswing in consumer spending once confidence is restored.

From the team’s discussions with companies on the ground, ‘we have the sense that the worst is behind us. Over the longer term, improving corporate earnings could be a key driver for investor confidence to come back.’

Meanwhile, he adds, valuations in the Chinese equity market ‘remain compelling both in historical terms and compared with some other major markets. Clearly, a lot of pessimism over the economy appears priced into valuations.’ 

DISCLAIMER: The author of this article has an investment in Henderson Far East Income. 

 

 

 

 

 

 

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