Chinese equities is an area that has struggled relative to the rest of the world and valuation figures may still push many investors away. However, we believe the medium-term outlook has somewhat improved and they could soon be the next key driver of performance.
Current market drivers
The conflict in Ukraine has increased the volatility of global markets since February of this year and, for better or worse, we know that markets don't have hearts or minds. However, the main driving factors affecting investments continue to be inflation and interest rate rises, rather than the ongoing war itself. At the time of writing, global markets were negative for the year, with many once-popular stock market areas, such as US tech, continuing to struggle following a tougher start to 2022.
Investors are not without hope though, and portfolios holding a diverse range of assets protected from some of the worst of these market movements is pivotal now more than ever. A sector that has been talked about a lot recently is commodities, investors have piled into commodity funds over the past few months as severed oil supplies from Russia drive up the price of gas and energy. Although we are overweight commodities as well, there is another area that we believe is being overlooked, and maybe for good reason, but with the right allocation could very well be the next key driver of performance.
China
Chinese Equities is an area that has struggled relative to the rest of the world. In the first quarter of 2021, the Chinese government aggressively added to regulations for its largest technology firms, imposing restrictions on gaming to tackle addiction and destroying for-profit education services almost overnight.
As a result, Chinese equities have lost more than half of their value from February 2021 to mid-March 2022. These self-imposed regulations, combined with the situation facing property giant Evergrande (amongst others), and continuing Covid-19 lockdowns have led to significant investor uncertainty.
Although the valuation figures will immediately push many investors away, we believe the medium-term outlook has somewhat improved. On 15 March 2022 the Chinese government expressed its desire to be more supportive of its stock market. This is a situation entirely different from that of the developed world and has sent Chinese equities up 15% from their lows. In April, Chinese equities outperformed most developed markets (ex UK) by posting a marginally positive return for the month, albeit with significant volatility.
Potential risks
The considerable headwind of their zero-Covid policy is having a dramatic effect on parts of their economy, but as medium-to-longer-term investors, we need to look past this. The Chinese government has an array of weapons it can use to maintain economic growth, and history tells us it will not be afraid to use all means necessary to support the economy. After all, it has set a very high bar for GDP and without additional support the economy will not be able to deliver on it.
Of course, investing in Chinese equities in isolation would come with a significant degree of risk, but the combination of lower valuations and more supportive government policy could be a very potent combination.
Our allocation
To try and make the most of potential China’s market has we have made an alteration to our global emerging market holdings. We cannot say whether the issues will persist over the short term, however, we believe that there may be opportunities for investors willing to look for them. In this vein, we have reduced the Baillie Gifford Emerging Markets Growth fund in favour of the FSSA Greater China Growth fund.
Chris Rush is investment manager at IBOSS. The views expressed above should not be taken as investment advice.