There are schools of thought on investment in China at the moment: back out, stay in, re-purpose, ie switch stocks. And why? Well, it all depends on the stocks impacted by the Chinese Government’s implementation of regulatory policies, which broadly seek to clamp down on stocks that perform contrary to the greater good of the community (common prosperity), such as – in this current swathe of regulation targets – technology stocks, gaming stocks, private online education services companies and food delivery companies.
While some investors have backed out, seasoned and long-term investors are less alarmed particularly by China’s move to protect its state by clamping down on anti-competitive practices and big tech firms.
These investors see such activity as nothing new. Those that want to stay in – and argue who can realistically opt to stay out of the second largest economic presence in the world? – look instead to other options, which are, not surprisingly, very often those that benefit the state.
The background to the sectors where China has placed restrictions is fascinating. The crackdown on the K-12 private tutoring sector comes from the rampant growth of the tutoring business that has exacerbated parental anxiety and increased the cost of child rearing.
As demographics in China are aging rapidly, the government is promoting policy to increase birth rates and for-profit tutoring is viewed as hindering this goal.
Then the Government has put limits on video game play time for minors aimed at reducing screen time (e.g., preventing eye issues such as dry eye problems in younger age demographics), reducing obesity in youth, addressing addiction (and other mental health issues), and as the younger generation matures and enters the workforce, to increase productivity.
Meanwhile the impact to the food delivery business is more around providing proper pay and benefits to drivers, so labour reforms.
What fund managers say
We asked fund managers how they see the country and its attractiveness or otherwise for investors and where their focus should lie.
Bill Kanko, founder and president of Black Creek Investment Management acknowledges that there was both concern/risk and opportunity with respect to the recent tightening of regulation in China.
“The risk is that the market becomes less investible due to restrictive policy decisions, but the opportunity comes if this “crackdown” is temporary and eases (i.e., substantial growth opportunities in the world’s second largest economy),” he said.
Black Creek’s contrarian nature means it finds many of its best ideas where others are not looking.
“We continue to do our due diligence and there is the potential to take advantage of further share price weakness and broad investor pessimism,” said Kanko.
Black Creek has limited direct exposure to Chinese technology stocks. One it is likely to continue to hold is Baidu, the largest Internet search engine in China with a more than 70% market share, where it derives significant advertising revenue.
Baidu is a technology-driven company and is considered a leader in artificial intelligence (AI) research, including technology for autonomous vehicles. It is also growing its cloud computing service offerings in China and Southeast Asia and is considered a leader in AI cloud services in China.
Kanko considered the company’s valuation attractive, particularly when the value of Baidu’s stake in iQiyi (a streaming service in China like Netflix) and its excess capital is considered.
“We view the industry wide campaign to increase data protection and ensure fair competition as positive for China’s technology sector’s development given an increasing compliance burden will further cement the leading positions that companies, such as Baidu, have built over the previous decade,” said Kanko.
The key is to identify those companies that can sustainably grow and compound shareholder value over the long-term, leveraging powerful secular growth drivers such as China’s continued transition towards a consumption-led economy.
China’s current social focus on ‘common prosperity’, sharing of wealth, fair employment rights in terms of pensions, pay and health plans for example and equality in terms of education, property and healthcare could be seen as commendable. It could salve investor concerns of human rights issues. Further, future targets may also appeal.
Andy Headley, head of global strategies at Veritas Asset Management, said: “China’s policymakers have identified four main pillar industries, namely energy conservation and environmental protection; biotechnology; next generation information technology; advanced machinery and equipment, in short, what some refer to as ‘new infrastructure’ development.
“Companies focusing on these areas may provide good long-term sustainable investment opportunities if they benefit from long-term competitive advantages and are available at attractive valuations.
“Whilst the short-term landscape has unsettled investors views on the likes of Alibaba, it’s highly probable the company will continue to play a pivotal role in supporting growth within the Chinese economy and benefiting from digitalisation in all aspects of life,” he added
“One area likely to grow significantly is cloud infrastructure, which is still in an early stage in China and an area in which Alibaba not only exceeds but is on the cusp of turning profitable.”
Craig Baker, who chairs the Alliance Trust Investment Committee, was sanguine about the portfolio’s exposure to China. He said: “We remain convinced that China is an exciting long-term investment opportunity and that it will play a much bigger part in the global economy and stock markets in the future, albeit in a potentially more politically polarised world.
“However, successful investing in China is all about being highly selective, which is why we’ve got expert stock pickers on the job, as opposed to taking a big bet top-down on the country, which could easily backfire.”
Mark Atkinson, is head of marketing and investor relations at Alliance Trust. The views expressed above are his own and should not be taken as investment advice.