Despite the doubters, China has not become uninvestable. But which Asian stock market has performed best since the MSCI China index was launched in 1992? Clue: it’s not China.
Or, as the more bullish investors claim, with economic growth set to exceed developed economies, is a significant strategic weighting in Chinese shares merited?
The first comment we always make here is investors must remember that stock market returns and economic growth do not correlate, particularly in the case of emerging markets.
The chart below is one we often refer to. It shows that the best performing stock market in the 20th century was Australia, closely followed by Sweden. Neither had anywhere near the best economic growth rate (using real per capita GDP growth) over that period.
Why was this? Clearly, returns on a stock market reflect the returns of the stocks listed in that market. The quality of those companies (management, industry and countries in which they operate etc) will define returns.
Even where we have domestically-orientated stock markets, returns will be affected by proper legal systems and protection of property rights. This at least in part explains why stock markets based in countries with sound government and independent legal systems like Australia and Sweden have done well.
Chart 2 has the respective MSCI returns (all in US dollars) from December 1992 when the MSCI China index was first launched.
As can be seen, the MSCI China has had the poorest returns over the period. The index is still actually below its starting level and even with dividends reinvested has only returned 1.9% p.a. over 30 years.
Our colleagues on the Japanese equities desk in London were particularly cheered to note that over this period the MSCI Japan has produced more than double the return of the MSCI China at 164% vs 75%.
Past performance is not a guide to future performance and may not be repeated.
The best performing market by some margin over the period is the MSCI Australia, which has returned 1892% or 11% p.a., which is actually slightly more than MSCI USA.
The ASEAN markets with a history of relatively poor capital allocation and government interference have offered mediocre returns, whereas those countries with better property rights and legal protection and few state-owned enterprises (Hong Kong, Taiwan and Korea) have done materially better.
Only India, where private sector banks and domestic entrepreneurs have been allowed to operate with less government interference, has really lived up to the emerging market promise.
Clearly on a long-term basis it would be hard for me to claim a large strategic weighting is justified to Chinese equities. This based on, firstly, past experience and, secondly, the fact that regulations appear to be moving China away from a market economy with property rights, to a socialist economy with a larger state.
No, it does not, but clearly buying a Chinese ETF to us looks an extremely unappealing long-term investment.
For some time, we have thought large parts of the Chinese market are uninteresting to us as Asian equity investors. These being the state-owned enterprises (banks, telecoms, utilities), heavy industry and mining (ESG and overcapacity), and real estate (overcapacity, opaque balance sheets, demographics).
This has left us focussed on internet stocks, insurance, selected healthcare, higher-end manufacturers and technology stocks and consumer-related names. What the current regulatory barrage has done is cause us to re-evaluate the exposure we want to have to internet, insurance and healthcare stocks as clearly some of them will become more regulated as their priority moves to helping achieve “common prosperity”.
So, China hasn’t in my mind become uninvestable.
Instead, the range of industries and stocks we are interested in investing in has become narrower, and the valuation we are willing to pay for certain stocks is lower, reflecting the new risks.
Many active China fund managers, including our esteemed colleagues Jack Lee and Louisa Lo, have demonstrated you can make good returns by investing in Chinese equities.
The key in China is to ignore the overall index as so much of it is fundamentally unattractive and instead really focus on stock picking. The universe in China is large so - despite regulatory concerns - many good investment opportunities exist.