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Experts from Schroders discussed these challenges and solutions in an article for Asia Asset Management. Jack Lee, Head of China A-Share Research and Angus Hui, Fund Manager, Asian Fixed Income shared their views and opinions on the topic.

Offshore listed Chinese equities have traditionally been the investable universe of choice for international investors seeking exposure to China and its economic growth story.

Meanwhile, the onshore markets over the years have also been increasingly made accessible via the QFII and RQFII schemes as well as the recently launched Stockconnect Scheme. More recently, MSCI’s inclusion of China A-shares has led international investors to reassess their existing China exposure.

Not only is the China A-shares market the second-biggest worldwide after America’s, it’s also home to some of the most innovative and fast-growing companies in the technology, industrials and consumption sectors as China continues to rebalance its economy.

Jack Lee, head of China A-share research at Schroders highlights key factors around valuation of onshore Chinese equities:

  • Capital source – In the A-share market, prices are largely driven by domestic capital (local investors) while in Hong Kong, or US ADRs, liquidity is mostly provided by foreign investors. The reality is that domestic investors have limited options if they want to invest overseas – given capital controls – and therefore the domestic market benefits. Based on this, the market should be priced according to what domestic capital is willing to pay and not on the outside perspective.
  • Dual-listed comparisons – So far only 97 stocks are duallisted in both the A-/H-share markets. Although the latest figures suggest that these names are trading at over 20% premium right now, there are more than 3,300 stocks listed in the China A-share market. It is far too simplistic to generalise with sweeping assumptions that this or that company’s valuation in the A-share market is not justified.
  • A-share market liquidity – The A-share market generally boats better liquidity than Hong Kong (perhaps with the exception of large cap giants) while trading turnover is also more evenly distributed and less concentrated – which should warrant some sort of premium.
  • Vastly different market structures – We cannot compare directly two different markets based simply on a multiple. For example, take the CSI300 and HSCEI which trade at PE multiples of 14x and 9x respectively. Whereas the former has a large proportion in mid-cap stocks, the latter has just 50 stocks and is concentrated in financials, with nearly half the index being made up of only four stocks. With the reshuffling of the CSI300 Index over time, the ‘new economy’ should be better represented – which is something Hong Kong’s market sorely lacks.
  • Better capital, better quality – A-share IPOs tend to be smaller scale, with large fund-raising actually coming in secondary placements. The screening process for mid-cap IPOs in China sees companies being scrutinised closely by the authorities. Arguably it is a tougher market to list in compared to Hong Kong’s market-based registration system and this more amenable fund-raising environment allows mid-caps to grow larger.

 

Dealing with debt

China’s fixed income market is of growing interest to investors too, but how should investors take into account China’s debt pile? China’s central bank is taking steps to rein in previous excess and fears over an eventual debt implosion seem to have receded for now. Yet is it doing enough and does this improvement bode well for China’s credit market?

Angus Hui, fund manager, Asian fixed income at Schroders says: “The People’s Bank of China has carried out the bulk of its interbank liquidity squeeze and we believe the worst is now behind us. The authorities have had some success in deleveraging – evidenced by a falling M2 money supply that has hit a multi-year low – while recent data on total social financing (TSF) has also been positive.

“In fact, we are seeing encouraging signs that state-owned enterprises (SOEs) are beginning to deleverage on the back of a strong recovery in profits aided by supply-side reforms. This is particularly true in industries which are experiencing overcapacity issues.

“Overall, we remain positive on the Chinese bond market given the relative value that both onshore and offshore Chinese bond yields are offering investors (versus global bond yields).

“The slowdown in growth momentum since July was expected given it came on the back of a cooling property market and financial leverage crackdown by regulators.

“On the onshore credit front, although quality does remain a concern, default rates have so far been very low and are mainly in industries hit by overcapacity. That said, we do expect a pickup in defaults and as a result favour high quality issuers.”

Important Information: This document is intended to be for information purposes only and does not constitute any solicitation and offering of investment products. Investment involves risks. This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.

Source: Asia Asset Management December 2017/January 2018

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