Last month, we talked about how the Chinese economy was set to slow down significantly in the next few years, and possibly stagnate. With the recent government crackdowns on many sectors, and all that coalesced to sour the mood of many investors toward China.
But there are some pockets of opportunity, especially when you remember some key numbers, as Fred Demers, Investment strategist at BMO Global Asset Management points out. By 2025, the country will represent one fifth of world GDP. “It remains a pillar of world growth, yet it only represents 5% to 10% of investors’ portfolios. Mind you, that underweight was not a bad thing in view of everything that happened recently,” Demers notes.
S&P-Like Diversity
China is a very diversified economy, a fact that distinguishes it sharply from emerging markets in general where economies are often structured around a few commodities, says Chris Heakes, director and portfolio manager, ETFs, also with BMO. In this respect, China’s economy resembles that of more developed economies. “China exhibits a very large and diverse index, very similar to the S&P 500,” he notes. That means the opportunity set is large and widening.
As a result, “we need to remain open to China, even if growth slows and demography declines,” Demers says, adding that “China is very preoccupied by the concentration of wealth, which threatens the regime’s permanence, but also the cohesion of society. China wants to avoid a pyramidal model of society to favour a more distributed one, with a larger centre.”
Capital Group portfolio managers Noriko Chen and Victor Kohn also share this perspective: “In some areas, such as cybersecurity and digital commerce, current rule-making and stricter enforcement parallel to a degree the efforts by policymakers in the U.S. and Europe to regulate the digital economy and protect consumers.”
Still Potent
The authors of the Capital Group article recognize that the regulatory wave is likely to continue in technology, notably in online gaming and mobile apps, but also in other sectors such as property development and consumer finance “as the government seeks to curb excessive risk and debt in the country’s financial system”.
Granted, the blows to Chinese technology giants spooked many, but there are other, less traveled, paths where investors can find solace. Heakes doesn’t think this is the end of the technology story in China. “China is such a major investment theme, we think regulatory hurdles will be ironed out. So, I still view technology as a growth theme. I think Alibaba (BABA) will continue,” he says. Heakes points to WuXi AppTec, a health care provider, while Demers singles out Anta Sports Products, a manufacturer of sportswear and Haier Smart Home Co., a producer of domestic electronic products, as good ideas as well.
The growth of the middle class is a major theme for many. The Capital Group article highlights the phenomenal growth there, the market value of consumer discretionary stocks, in three years since July 2018, having gone from US$ 170 billion to US$ 943 billion, and of communications stocks, from US$ 71 billion to US$ 503 billion over the same period.
A Different Shade of ESG
However, the Capital Group report highlights some sectors that stand to “benefit from these recent policy pivots and regulatory actions”, including those already receiving financial support from the government. The report weighs heavily on the side of green energy, electric vehicles, pharmaceutical and medical innovation, software and IT services.
The ESG theme, so popular in North America, has another flavour in China, warn Morningstar analysts. For one, it is barely taking off, notes Verna Chen, Associate analyst, Manager Research at Morningstar in Shenzen. “Sustainable funds are still in their early stage of development in China. We haven’t seen a strong preference for sustainable products so far. However, the Chinese government has issued a series of policies related to climate change and environmental protection. We expect this to spur asset managers to continue to develop and launch products in this area. Meanwhile, with electric vehicles being such a hot theme, some new energy vehicles or renewable energy theme funds may attract net new assets,” she says.
China’s track record on the ESG front is far from impeccable. As recently as October 2020, Frank Pan, Manager of Asia-Pacific Research at Sustainalytics, could write: “Chinese equities are distinguished by a relatively unattractive combination of high ESG risk levels and high P/E ratios.”
Pan developed an ESG-at-a-reasonable-price (ESGarp) score which showed low numbers for China, worse than those of South Korea and India. In 11 major sectors, such as consumer discretionary, financials, IT and industrials, all scores came out between -negative 30 and negative 50, with only one exception, but still negative: healthcare, coming in at -12.
That’s not to cancel out all opportunities. Some are noteworthy, says Heakes, pointing out a strong performer like China Merchants Bank (3968.HK) which at the same time “appears as an ESG leader”, he says, branching out in the area of micro-loans to SME companies. Nevertheless, tread carefully.
