Perspective

What’s behind the summer storm in Chinese equities?


While US and European equity markets remain close to their recent highs, Chinese shares are having a difficult summer. China's benchmark CSI 300 index ended July almost 20% below its peak earlier in the year. Many Chinese companies listed in the US have suffered even greater losses, as investors questioned whether the complex structure used to list overseas could come under threat.

The falls accelerated late in July, after the government required listed education companies to convert into non-profit organisations, undermining a lucrative, fast-growing sector. Investors saw this as part of a wider regulatory clampdown. Since last November, there have been close to 50 significant regulatory actions, including measures targeting digital payment provider Ant Group, online service provider Meituan and the ride sharing app Didi Global, among others.

Chinese markets have rebounded slightly after official reassurance that the latest set of measures were targeted and would not be applied to other industries. The People’s Bank of China helped improve sentiment by providing extra liquidity to the banking system. And concerns over the status of US-listed Chinese companies have eased following press reports that the government would continue to allow companies to go public in the US.

We remain positive on the longer-term outlook for Chinese equities. The country has many innovative businesses that are well placed to benefit from continued growth in consumption. However, we think that volatility could remain elevated in the short term as uncertainty over the regulatory outlook persists.

What are Beijing’s objectives?         

Recent developments point to a material shift in policy direction for China. We think the latest regulatory measures are designed to promote greater equality and fairness, while also encouraging investment in areas considered a priority by the government.

Many of the regulatory measures have been focused on technology companies. This scrutiny is not unique to China: “big tech” is under the microscope everywhere, due to its size, alleged anti-competitive practices and significant control of consumer data. However, China’s political and governance system allows it to act far more quickly than Western governments could hope to.  

China’s clampdown may also have other, more specific, motivations. The government may be using regulation to pressure internet companies to provide more support to traditional industries, many of which are struggling in the face of low-cost, online competition. The authorities could well be concerned about data leaks, especially by those companies listed in the US. Meanwhile, measures against the education providers, which cater primarily to the wealthy, may reflect concern that these companies were promoting inequality. 

It is difficult to know how far the government and regulators will go to enforce this new strategic direction. Further announcements cannot be ruled out. However, greater regulatory and political risks are a feature of emerging markets in general and something that we and our managers factor into our analysis when allocating capital.

How are we positioned ? 

We have meaningful exposure to Chinese equities in our core sterling strategies. In our balanced strategy, for example, our exposure to stocks listed in China or Hong Kong is equivalent to around 10% of our overall equity exposure. This compares to their weighting of 5% in the MSCI All Countries World Index.

We remain comfortable with this exposure. We continue to believe in the long-term growth potential of Chinese equities and think that markets have now priced in higher regulatory risk. Our active managers are well placed to factor this risk into their analysis and take advantage of potential opportunities that may arise. Many of our managers in fact reduced exposure to Chinese equities as they saw regulatory pressures start to increase late last year.  

We also have a modest exposure to Chinese government bonds in some portfolios. They can provide defensive ballast in the event of market drawdowns, while providing a higher level of income than developed market bonds. We also expect more flows into the asset class as the government continues to liberalise financial markets and China assumes a larger weighting in global bond indices. 

Our view on China’s currency, the renminbi, remains positive given the better fiscal and monetary position of the Chinese economy compared to many other markets. Capital controls reduce the volatility typically associated with emerging market currencies.

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Isabelle Blöchlinger-Brechbühl

Isabelle Blöchlinger-Brechbühl

Head Switzerland, Germany & IAM, Zurich
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