The rollback of China’s zero-Covid policy and signs that the government is rethinking its over-zealous approach to regulation have led to a rebound in the country’s stock market: data from FE Analytics shows the MSCI China index is up 44.5% from its lowest point last year.
However, Wenli Zheng, manager of the T Rowe Price China Evolution Equity fund, pointed out that with institutional holdings of Chinese equities at their lowest level for more than five years, and cyclically-adjusted valuations far below average, the risk/reward ratio remains favourable for the region.
Having just entered the Year of the Water Rabbit, five managers reveal how they are planning to take advantage of China’s bounce.
Small-cap tech
Sara Moreno (pictured right), manager of the PGIM Jennison Emerging Markets Equity fund, said that while it is important to keep one eye on the direction of government policies, few equity investors can claim a fundamental competence – let alone ‘edge’ – in divining the intentions of China’s leaders.
She said that more important to investing in China is seeking out companies with strong growth potential whose products and services are aligned with the government’s strategic priorities.
In this context, and given China’s dependence on imported fossil fuels, she said the country’s green energy sector looks particularly attractive.
“In addition, we are focusing on smaller Chinese companies with disruptive technologies less correlated to macroeconomic and policy concerns,” the manager added.
“These smaller tech companies tend to pursue innovation in line with the Chinese Communist Party’s objectives and face less regulatory scrutiny.”
Experiences
Many fund managers have spoken about a shift in consumer spending away from possessions and towards experiences.
Sunny Bangia (pictured left), a portfolio manager at Antipodes Partners, said companies in China that facilitate leisure activities should benefit from an even more powerful tailwind in the short term as citizens will soon be able to partake in the everyday social interactions denied them while large parts of the country remained in lockdown.
“We will see people going to entertainment functions, sporting events and celebrating holidays,” he said.
“With that, an interesting point will be what happens to businesses exposed to that part of the market, such as Wuliangye, the second-largest baijiu white spirits maker in China.”
The manager said that Wuliangye is a high-quality structural growth business, even though it has suffered from two years of earnings downgrades due to the country’s lockdowns.
“When the economy reopens, we think the business will be on a reasonable earnings multiple of about 18x, which is a 15-20% discount to global spirits businesses around the world,” he added.
ADRs
Antoine Denis, head of advisory at Syz Bank, claimed there is plenty of potential in American Depositary Receipts (ADRs), an equity security created to simplify foreign investing for US citizens.
Ever since the regulatory crackdown started with the cancelation of the Ant Group IPO, Chinese ADRs have been under stress, losing about 80% of their value and being perceived as uninvestable by major US financial firms.
However, Denis said most of the declines can be explained by geopolitical factors rather than fundamentals, creating opportunities for bottom-up investors.
“China ADRs remain very cheap in comparison to US counterparts, and margins are still attractive – even if cut in half,” he said.
A broader emerging markets fund
With the MSCI China index having already made significant gains since last year, some investors may worry they have missed out on the opportune time to buy in.
Charles Walsh (pictured right), manager of the Mirabaud Equities Global Emerging Markets fund, said that anyone in this camp may wish to consider a more general emerging markets fund.
While China is the biggest weighting in the MSCI Emerging Markets index, at 32.3%, this benchmark is up a more modest 16% from last year’s trough. However, Walsh said it was “hard to overstate” the significance of China’s reopening to emerging markets in general.
“The restrictions during 2022 had a hugely negative impact on supply chains, employment and sentiment,” he explained.
“As activity normalises with the relaxation of restrictions, at the same time as the regulation of property and platform company sectors eases, this should provide significant support for China equities and emerging markets more broadly.”
Property market bonds
Turning to fixed income, Neuberger Berman portfolio manager Wei Siong Cheong said he was especially enthusiastic about the prospects for convertible and property sector bonds.
“Convertible bonds participate in equity upside, with limited downside risks,” he explained.
“On the property front, a significant portion of China’s high yield property bond universe is trading at distressed levels. The recent emphasis on improving the balance sheets and financing capability of systemically important developers reflects regulators’ intention to support the sector and ringfence better names. Homebuyer sentiment will also likely improve.”
The manager said these factors have yet to be priced in by investors, meaning the sector should provide a source of potential upside in the months ahead.
In contrast, he is less optimistic on the outlook for duration, saying stronger growth and increased supply pressure should keep rates grinding higher for most of 2023.