While highly volatile and subject to deep sell-offs, Chinese equities have gained significantly more than developed markets over this period as sentiment towards the rapidly urbanising country’s leap into a more open market economy showed no signs of abating.
According to FE Analytics, the MSCI China has gained 284.71 per cent over the past 10 years - more than double the S&P 500 index and the FTSE All Share and almost triple the MSCI Europe ex UK.
Performance of indices over 10yrs
Source: FE Analytics However, as every investor should remember, past performance is no guide to the future and Chinese equities have shown significant periods of downside.
In fact, an investor buying on the eve of the 2007 sell-off prompted by the looming financial crisis would have only recovered their money a month ago.
Also, only about half of specialist China funds have beaten the index over the medium term of three years and only about 17 per cent have done so over the longer term of 10 years.
Pessimism has abounded over the past few years as commentators fretted over a ‘hard landing’ into lower economic growth, a crisis springing from the country’s shadow banking sector, the end of the US’ QE programme and the challenge to implement suitable reforms for a more consumption-led economy.
However, the market has been re-excited over the past six months as news broke that global investors be able to access mainland China listed stocks via Hong Kong.
The Hong Kong-Shanghai Stock Connect policy – launched this week – allows international investors to gain exposure to the China A-share market, notes Cazenove economist Janet Mui, who warns they must contend with the problem of an asymmetry of information.
However, bulls such as Anh Lu, manager of T. Rowe Price Asian Ex-Japan Equity fund, and Jonathan Pines, manager of the Hermes Asia ex Japan Equity fund, are expecting further re-rating.
“This is another important experiment in the opening of China’s capital markets and the internationalisation of the renimbi. Our hope is that the limited quotas that the Connect begins with will be expanded over time, and its scope will eventually cover Shenzhen as well as Shanghai,” Lu said.
Pines says in anticipation of the new policy he has significantly increased his fund's exposure to China stocks.
“The A-share market is the world's second-most liquid market after the US, and ahead of Japan. However, the fact that trade is currently dominated by relatively unsophisticated domestic retail investors has resulted in significant inefficiencies. That does not mean most A-shares are cheap, even though the benchmark has declined for years,” Pines said.
“Indeed, the apparently undemanding headline P/E multiple of 9x for the local benchmark is distorted because a high proportion of the benchmark consists of banking stocks, which are cheap for a reason.”
“This is namely investor worries over banks' levels of leverage – particularly off-balance sheet debt. In fact, most A-shares are expensive relative to their quality, with well-governed companies generating free cash flow still a rarity.”
But Mona Shah (pictured), senior analyst at Rathbones, says the Shanghai-Hong Kong Stock Connect Program is not a cure for Chinese equities downside risks.
“It seems to me that most people are unrealistically excited about this programme. 80 per cent of the Hong Kong market is already owned by foreigners,” she said. “This program is clearly designed to attract even more overseas investors into mainland China markets. I don’t see the medium-term attractions here for many different reasons.”
“Shanghai has different trading hours and higher settlement fees [than Hong Kong]. Hong Kong has no capital gains tax. This tax is 10 per cent in Shanghai so perhaps A-shares should trade at a discount. Quotas remain for the volume of stocks that can be traded and will be reduced subject to the Chinese government’s prerogatives.”
She says Shanghai stocks trade in a different currency while voting rights are different in Shanghai. Meanwhile, holding periods are often very short and as a result volatility is higher than Hong Kong.
“Corporate governance in China remains largely poor; CLSA data shows they have made little progress over the last two years,” she added.
“Investors lack confidence in Chinese corporate governance. China was considered a pariah until recently.”
She says this remains the key barrier for global investors.
“Progress here would certainly be rewarded and is necessary for the programme to be a long term success. The long-term implications could be sizeable, for example, the liberalisation of the renimbi, the capital account and the programme could be extended to other asset classes.”
“However, Beijing may have created a catch 22 for itself as the more it liberalises its markets, the greater demands will be for corporate governance and rule of law by investors. Perhaps they should be thanking the protestors in Hong Kong for a giving them a heads up on the beast they could be unleashing.”
