A combination of messy political reform, unwelcome market interference from the Chinese government and a huge divide in share types are the largest contributing factors to the Chinese stock market sell-off, according to Henderson’s Charlie Awdry (pictured). 
The manager of the Henderson China Opportunities fund says China has found itself at a crossroads both economically and politically, which has caused uncertainty in terms of consumer sentiment and has created extra volatility in the emerging market.
From September last year, the Shanghai Composite started to rally and made 53.87 per cent total return by the end of the year. The market continued to rally throughout 2015 until June, when it began plummeting at rapid rates which alarmed markets globally and led to a mass sell-off last week which was quickly dubbed ‘Black Monday’.
Performance of index over 1yr
Source: FE Analytics
While Awdry agrees that the Chinese market is more complex than ever and requires extreme attention from investors, he says the situation has been exaggerated through the media’s emphasis on the mass movements of the Shanghai Composite index.
“A lot of people are very confused about where China fund managers are actually putting their clients’ money and a lot of what is going on is that Shanghai is creating good headlines, but is actually less relevant for a lot of people,” he pointed out.
“In terms of our China fund, we do have money in the A share market and we have money in B shares too. Most of it is in Hong Kong-listed Chinese companies.”
The manager has also been buying ADRs or American depositary receipts, which are stocks that trade in the US but represent a set number of shares in a foreign market.
“We’ve been buying ADRs a lot because they’re mostly in the service sector and have a good cash flow. Also, because they’re in America and America is the heartland of the bearishness on China, all these shares are really quite cheap,” he explained.
There are still investment opportunities in the troubled market, according to Awdry, but many investors will still be unnerved by the volatile behaviour of the Chinese market recently and the uncertainty behind what caused it.
While the manager admits there are too many contributing factors to implicitly explain and list, he does believes there are a set of major contributing factors to the market sell-off.
The first, he says, is political. Current president Xi Jinping, the general secretary of the Communist Party of China and president of the People’s Republic of China, was elected in March 2013.
His election was initially well-received by the market, causing the Shanghai Composite index to spike at its highest level that year.
Performance of index in 2012
Source: FE Analytics
However, the concept of a communist party official deciding to embrace market prices and to use them to direct the region’s pricing of oil, electricity and even interest rates was a drastic change for China, according to Awdry.
He adds that this, combined with Xi’s introduction of a huge anti-corruption drive, had a bittersweet impact on the emerging market.
“If you’re an investor you really do want to invest in a country where the rule of law applies as much as possible, where corruption isn’t the reason you get business deals and where policy doesn’t change all the time, so that’s good,” he said.
“The downside of this is, if you think about how the Chinese economy works and who makes the decisions in the Chinese economy, at most levels it is communist party officials. This anti-corruption drive has been at all levels – they call it ‘tigers and flies’.”
“Those right at the top on the standing committee have been politically assassinated and put under arrest and so have local government officials. If you think about GDP statistics, the guys and the politicians who are saying yes to projects that build roads, that build factories, that create a GDP number are very worried about their position.”
“They’re worried because I’m fairly sure that some of them will have taken back-handers at some point, and therefore they’re worried whether the HR department of the communist party is going to ring them up and call them back to headquarters.”
As a result, Awdry says officials are reluctant to spend money, which is one of the main reasons why economic activity in China is slowing and falling.
In addition to this, the manager says Xi’s intervention in the Shanghai market has called his pro-market and pro-reform reputation into question.
“What we say is that the reform is at a crossroads. Everything was going fine until July when they panicked and they started to intervene in the stock market so that the retail investors in China didn’t take too much of a hit,” he explained.
“I can’t think of many more market-based prices than the stock price, because it is supply and demand from the market, so he’s actually gone straight back against what he said.”
Awdry says the complexity of China’s political situation and the huge changes that the Chinese economy and Chinese market have endured over recent years have taken their toll. He argues that, before this years’ sell-off, the growth of the Chinese economy triggered by bullish China investors has left behind a series of problems.
“Firstly it means a lot of debt and secondly an acute amount of corruption. President Xi is trying to do things differently now – he’s trying to grow, reform and deleverage, and there’s a feedback loop between all of these things,” the manager continued.
“What you’re seeing right now is the fact that they are continuing to reform and are focusing on leveraging, which has really hurt growth. What will probably happen now is they’ll panic that growth has been a bit soft and they might go back on reforms, they might go back on deleveraging.”
“This is basically not simple any more. China is not a simple economy to understand, it’s not a simple investment idea to convey to clients, but what we’re saying is the economy will muddle through. But there is no way that this economy is growing at the 7 per cent that they’ve printed.”
Awdry and his team tend to look at car sales as a good indicator of consumer demand and believes that, while overall data is lacklustre, there are certain areas of the Chinese car market, such as SUVs, that are still growing 35 to 40 per cent year-on-year.
As a result, he sees the auto area of the Chinese market as an appealing play at the moment due to the single-digit price/earnings ratios the area offers and the fact that the companies often have a strong cash flow.
“The market is split between frankly boring, mature businesses that are quite cheap and sexy high-growth technology shares that are extremely expensive. The reason it is split like that is because those expensive shares are the ones that retail investors love,” he explained.
“I’ve really got no idea where the Shanghai market is going and you’ll get daily updates on Twitter saying whether it’s up or down. I personally am trying not to get drawn into that waste of time because actually, if you look at individual stocks, there are some very, very cheap ones that offer great investment opportunities.”
Over Awdry’s nine-year tenure, Henderson China Opportunities has outperformed its peer group composite and its MSCI Zhong Hua benchmark by 5.94 and 25.53 percentage points respectively.
Performance of fund vs sector and benchmark over management tenure
Source: FE Analytics
The four FE Crown-rated fund, which is £576m in size, has a clean ongoing charges figure of 0.87 per cent.
