Finding Value in China – Investment Strategies for the Year Ahead
Nov 1, 2022
- CSOP Asset Management
- GAM Investments
- Jaye Chiu, Head of Investment Products & Advisory, Bank of East Asia
- Barbara Lee, Vice President, ETF Strategist, CSOP Asset Management
- Jian Shi Cortesi, Investment Director, GAM Investments
- Jeffrey Wong, COO, Hywin International
- Arjan de Boer, Head of Markets, Investments & Structuring, Asia, Indosuez Wealth Management
Setting the Scene for the Discussion
In a Barron’s report on investing in China in late July, Virginie Maisonneuve, global CIO for Allianz Global Investors, offered some valuable views on how investors should be thinking about their allocations to China. She indicated that given the size of the Chinese economy and of its capital markets, China should be considered as its own asset class by investors, essentially having risen well above standard emerging markets. She indicated that China offers diversification in portfolios, given how the economy is managed along its five-year plans. For example, she noted that while the world is tightening monetary policy, China is doing the opposite.
Nevertheless, China’s equity markets have suffered sharp falls in 2022, with the MSCI China All Shares index down about 37% from December 31, 2021 by mid to late October.
With the government’s surprise regulatory and other policy measures of 2021 now hopefully in the past, and with the very recent ruling Party Congress emphasising technology, innovation, renewable energy and domestic consumption, is this now a good time for investors to be buying back in?
And if they should be increasing their allocations to China, how should Asia’s private clients be approaching the Chinese markets? Stock picking? Through actively managed funds? Through ETFs, smart beta strategies and thematics? Equities only? Or fixed income? Onshore securities? Or through offshore access only? Or perhaps a combination approach?
The Hubbis Digital Dialogue of October 20 saw a panel of experts from the asset management and wealth management communities offer their perspectives on the value – or perhaps lack of - that China represents today, opining on the right approaches to China’s vast equity and debt markets for Asia’s private clients, and what to watch out for in the future as potential warning signals that the economy, the markets or politics might be going off track.
Views from the Experts – Drilling Deep for China’s Investment Nuggets
The key takeaways from the Party Congress? China means business and much more of that will be at home
An expert opened proceedings by observing that aside from the controversy around the apparent ejection of a prominent older party member, President Xi and his team mean business. “Development is the top priority, economic growth is still the key focus,” he reported. “The goal is to have the per capita GDP reaching the mid-level developed countries in 15 years. And the government also reaffirmed the commitment to the market economy and support for private sector. These are welcome messages.”
He explained that in terms of the engines for the economic growth, four key elements were emphasised – industrial upgrades, technology innovation, energy transition, and national security.
“Our take from all that is that innovation, particularly import substitution in technology, will be a key theme going forward,” this expert explained. “More consumption will be a more important role in China's economic development, China will continue to pursue opening up and to promote an open world economy. And China sees international cooperation as a key to the global economic recovery, so we also expect to see more financial market opening.”
He said the speeches also indicated that energy transition is an important theme, but it will be a steady change. “That implies it will be a more pragmatic approach, meaning that when renewable energy capacity is available, then traditional energy will be retired. In short, this is also very similar to the five-year plan, which emphasises economic growth, innovation, clean energy, and security.”i
But he added that there was some disappointment in a lack of commentary on lifting zero covid practice, and around the stressed property sector.
Help! The Hang Seng Index has plummeted! And the negativity is mostly about China…
A guest pointed to the collapse of the Hang Seng Index in Hong Kong, which hit an all-time high of over 33100 in January 2018 and that is now trading at below half that level, a 13 year low. “That simply means that a lot of people are very concerned about Chinese equities, and unfortunately we do not really have a very constructive view of Chinese equities either,” he told delegates.
He cited their reasons. “China is facing major demographic challenges with the aging population, the zero COVID policy is a major negative, the Chinese property meltdown and the slowdown in the market is challenging, the quite unpredictable regulatory agenda from the Chinese government is worrisome, and also, last but not least of course, the geopolitical tension with US, and the technological warfare. These are all factors that will continue to weigh on investor sentiment.”
He said that while valuations have come down a long way, that does not mean they will go back up soon. “Valuations are now quite cheap in Chinese equities, but we also know cheap can remain cheap for a very, very long time,” he said. “Investors are still voting against China; money is going out of the equity markets at roughly three to four times more than the inflows for the past couple of years. And as we see it, the capital flows will unfortunately continue to move out of emerging markets because of the interest rate spread vis-à-vis the US Dollar, and there will still be continued selling pressure in the Chinese equity markets.”
However, he said there are still see some sectors that appear to have value, for example, green energy, EVs, domestic consumption. “Nevertheless, we remain generally cautious,” he concluded.
The Hubbis Post-Event Survey
What is your outlook for Chinese equity investments for the year ahead?
Positive but selective 73%
Marginally negative 24%
Really negative 3%
What percentage exposure should Asia’s private clients have to the Chinese equity markets as a % of their APAC equity holdings?
More than 60% 3%
Less than 20% 18%
What percentage exposure should Asia’s private clients have to the Chinese equity markets as a % of their global equity holdings?
More than 60% 3%
Less than 20% 49%
What percentage exposure should Asia’s private clients have to the Chinese fixed income markets as a % of their global fixed income holdings?
10% or less 43%
What is the best approach to Chinese equity market investments for Asia’s private clients?
Passive funds 30%
Active funds 52%
How should investors best access China’s equity markets?
‘A’ shares 42%
‘H’ shares 40%
US listed stocks 15%
Globally listed (non-US) stocks 3%
Are you recommending your private clients buy into the domestic Chinese debt markets?
Yes, big time 3%
Yes, just to test the waters 12%
Not yet, but watching closely 79%
No way! 6%
But is China simply too big to turn your bank on as an investor? Some think so, yes…
Despite the negatives, another guest said China is too big and distinct for global investors to ignore despite a host of what he described as significant but temporary setbacks.
“The second largest economy in the world, its GDP has increased fivefold in the past 20 years, and while growth will be slow ahead, it will still be growth,” he stated. “We also foresee quality growth. China in 2020 accounted for 48% of the world's exports. The financial markets are developing fast, and China now has the fourth largest stock market by share of total world equity market value. So, yes, short term wobbles, but indeed, a global economic superpower. Accordingly, for the long-term view, we are constructive in general Chinese equities.
He said the Hang Seng being so far down and the MSCI China and the CSI300 some 15% below what his bank thinks are their long-term average levels, they see longer-term value. “You can’t pick your bottom or your top, so we are saying people should invest,” he stated.
And what about the US-China tensions and Biden’s so-called trade wars?
An expert on the panel highlighted how the US deficit with China had reached a record high, and that is three years after the trade war started. “We will surely see more and more friction in this rivalry between US and China, but China is vast and nowadays so much more of the development of the economy really comes from internal momentum, the drive to innovation and domestic consumption. The US tensions could in the short term hurt certain industries, but it doesn't change the long-term trajectory.”
He said that foreign investors have long tended to be at the extremes of positive or negative about China and with the MSCI China All Shares at only around one times book, there is clearly a lot of negativity currently.
“But if you do believe that China will still be among one of the fastest growing countries, then you should look at China, especially when it's trading at very low valuations,” he said. “If you wait for all the factors to be positive, you will be buying in to a market that has already rebounded 40% plus from the bottom, as we have seen in all the previous cycles. So, unless you believe that going forward, China will be slow, not grow anymore, you should really look at buying back into China.”
He highlighted in particular some of the tech growth companies that are down 80% or more to trade at historically low valuations, but many of which are of late reporting better than expected earnings. “This must be an opportunity, so choose the right companies at low prices and wait for investor sentiment to turn upwards.”
Many of the jigsaw pieces are coming together to paint an interesting picture, but the key focus must be to seek out value
Another guest said China is on track to hike domestic demand and consumption, to enhance technology and drive to superpower status, and his firm’s general position is to point investors away from risk and to value stocks. “China is an emerging market still and we are still on neutral generally to EM, but we do see pools of value,” he reported. “Moreover, we see rising interest in fixed income and good value in Chinese stocks that are listed in US.”
ETFs offer an interesting and relatively safe and liquid approach to China
An ETFs expert highlighted the value of ETFs for mid- or long-term exposure to what is a volatile market, and how private clients can make good use of leverage and inverse products for short-term trades or even to hedge their portfolio using inverse products.
They said that buying single stocks is a risky proposition but focusing on ETFs will offer investors broad-based exposures to key segments that will enjoy the right propulsion from central government. They pointed for example to a Hang Seng technology ETF that tracks all of the leading Chinese tech players in the market, or to capture rising domestic consumption another ETF that tracks the consumer staples.
And they highlighted thematic ETFs such as their very popular ETF focused on PV, or photovoltaic, centred on solar power as a key element of the thrust to green energy and renewables. “This focused not only on the makers, but also the whole supply chain, including the polysilicon, the cells or the solar panels, allowing investors to gain broad exposures without being any form of expert,” they reported. “And China actually exports most of the solar-related materials or end products to the world, so it should be a key focus of private portfolios.”
This same expert also pointed to the success of their leverage and inverse ETF products, especially for hedging purposes.
The actively managed approach, for some, is the best route into China’s complexities, often with contrarian thinking producing interesting results
Another guest highlighted their actively managed strategy that he reported had outperformed by a significant margin in the past decade, in up and down phases.
“We focus on the attractive sectors, we drill down into the best companies, and we analyse prices and potential,” he reported. “Actually, some of the best ideas we have now are all contrarian ideas, where investors have sold heavily, where there is excess pessimism and misinterpretation of potential. For example, real estate has been one of the best performing sectors in our strategy year to date, because we pick the highest quality real estate developers; they had been beaten down because everybody sold real estate stocks, but they don't realise that the high-quality real estate developers are actually benefitting from the current slowdown.”
He said another contrarian idea is the internet companies. “Do you really see a growing economy in China where the internet companies don’t grow? That is not easy to imagine. Actually, some of them are beating expectations but still trading at historical low valuations. In our past experience, it's only when you go against consensus, you buy when other people don't want to buy, that you can get the best deals.”
He said the passive versus active debate is often on the agenda. “If the client is looking for short term market rebound type of trade, we think that ETF offers a lot of value, as ETFs are very cost efficient, and in recent months we've seen more and more clients using ETF as underlying for flow structured notes. On the other hand, if the client is looking for more long-term exposure to China, we think that active manager is still the way to go, because the China market particularly the ‘A’ shares tend to be quite retail focused and driven, opening up more leeway for managers to derive alpha as they look for inefficiencies.”
China is dancing to a different fiscal turn to the mainstream develop economies
A guest highlighted how China has considerable flexibility in its fiscal position and does not suffer from the throttling of QE or rising interest rates. “China is still a very modest fiscal policy at the moment. We see there's a higher probability [in the developed markets] of recessions but China is insulated, and they are going headlong for domestic consumption.”
But he advised clients to take an active management approach to the market. He said that US equity is still at multiple-year highs, and they are underweight that market, neutral in emerging markets, neutral Switzerland, neutral in Japanese equities, and also Europe. In terms of the currencies, he said they are actually seeing only a stronger Dollar for the time being, not seeing any currencies that are able to beat the greenback and it offers a yield, meaning there is an opportunity loss of 4% or 5% for not holding it. And that means that if investors buy into equities, for example Chinese equities, they need to see enough returns to justify taking the risk. “I would be happy to jump into China by the end of next year,” he said.
Views on the Chinese currency – a mixed and uncertain outlook but more likely nearer term weakness than strength versus the dollar
An expert pointed out that the Chinese yuan is referenced to a basket of currencies, for example the Euro, Japanese Yen, British Pound, and other currencies, so when some or all of these currencies depreciate against the Dollar, the Chinese Yuan will follow them.
“The Yuen will therefore fall, but end up in the mid-range of drops, and then on the other side, when those currencies rise again, the Yuan will also appreciate but also in the mid-range,” he explained. In short, investors views on the Yuan should reflect a tempered view on those other developed market currencies. “I am not a currency expert, but historically, normally the US Dollar will peak when the Fed stops hiking interest rates.”
Another guest agreed that US dollar strength will persist, especially as there will be another rate hike in November. “But if we're looking into a long term, for example, in one year, I think the correlation or the beta of the Dollar-CNY would likely to reduce when we talk about the sensitivity, especially we expect there will be some regulatory measures or verbal intervention to tighten the offshore CNH funding costs,” they commented. “That will make it more painful for the offshore investor to short the CNH.”