Investing in China: Chinese equities
Chinese equities set to benefit from the rise of the new growth model
At the recent conference held by Schroders on the Chinese financial markets, Stephen Kam (Investment Director for Asia Ex-Japan Equities at Schroders) presented the outlook for the Chinese equity markets. “We do think that China is entering a new growth phase”. China's old growth model, based on heavy investments alongside a reliance on exports, will remain an important part of the economy but will be less and less relevant to the growth trajectory. “The investment into infrastructure will continue, but the nature of that infrastructure investment is changing, from building bridges and roads to building IT infrastructure. The old model has now largely run its course”.
Productivity gains
In the future, he believes that China’s growth will mostly come from domestic consumption of goods and services, and that the health of the Chinese economy will be the main driver of equity market returns. At the same time, the Chinese population is getting old rapidly, which means that productivity gains will be crucial to maintain a sustained level of economic growth going forward.”As investors, we need to allocate to companies that are going to drive improvements in productivity in China”.
“The gains are largely coming through on the back of investment into the new infrastructure projets and into the people”. Stephen Kam points out that the well educated workforce is one of the main arguments backing an allocation towards Chinese equities. “The current geopolitical climate has pushed R&D investments by Chinese companies over the past couple of years, and this trend will continue to accelerate. The intellectual property actually being developed in China will allow the stock market to remain a good place for investors”.
Index inclusion
Going forward, he expects the international investors to drive the flows towards Chinese companies, since the market still represents only a very small portion of their asset allocation. “The inclusion of the onshore domestic equity market (A-Shares) into global equity indexes will also support the funds flows. At full inclusion of the A-Shares market, China should represent around 50% of the emerging market indexes”.
“The really exciting and relatively new opportunities lie in the A-shares market (Shanghai and Shenzhen stock exchanges), which has only recently opened up to international investors. This is where the vast majority of China’s market cap resides and where you will mainly find companies geared towards the domestic consumption”. Stephen Kam also points out that the A-Shares market is still relatively immature and inefficient, with 80% of the turnover being driven by the retail investors. “That gives active managers a very good opportunity to actually outperform the market, which has been the case over the past five years”.
In the near term, he expects the Chinese authorities to keep on doing a great job with the Covid-19 outbreak. “Therefore, we remain quite confident with respect to the earnings outlook for a lot of Chinese companies that we're investing in. While the path to normalization could be very bumpy in some areas of the world, China’s path should be, on a relative basis, much smoother”. This should prevent any strong change of direction for both the monetary and fiscal policy over the coming months.
Sector allocation
The valuation of the Chinese market is the key challenge at the moment, after the strong performance of 2020. Stephen Kam points out that both the onshore and offshore market are currently trading with a premium compared to its long term average. “Sectors such as biotech, Internet and e-commerce have done really well during the crisis, and those providing structural growth have seen their valuation increase to a relatively high level. So we need to do a little bit more digging to find those good ideas, offering structural growth at a good value”.
For instance, he points out the attractiveness of the electric vehicle space, especially considering the fiscal incentives put in place. “We prefer an exposure through component makers that will benefit irrespectively of the carmaker that will win market share. Companies active on automation are also a key component for the Chinese economy, as they fit in the search for productivity gains over the long term”. He also likes technology hardware since it has somewhat lagged the strong market performance in 2020. “In the short term, we are also underweight the internet and e-commerce names due to the anti-monopoly regulation and due to valuation reasons. Over the long term, we also expect the growth of these segments to remain very strong, but the short term outlook is more uncertain”.
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