Retail investors around the world have flocked to equity markets in recent months as stimulus packages have been launched to support markets and ultra-low rates have lowered the returns available on risk-free assets.
As such, investors have sought out companies with better growth prospects and well-positioned in the Covid-19 pandemic, but it has fuelled concerns about stretched valuations.
However, despite a growing number of retail investors driving Chinese stocks higher, the country’s equity market still isn’t as frothy as others, according to Jian Shi Cortesi (pictured), investment director of Asian equities at GAM Investments and manager of the $85.4m GAM Multistock China Evolution Equity fund. 
“In China we have seen a similar phenomenon of increasing retail participation,” she explained, “but because of the unique structure of the Chinese capital market – which prevents Chinese retail investors from investing outside of China – the retail trading impact has mainly been on the domestic ‘A’ shares.”
Within the domestic market, Cortesi has observed that quite specific sectors are preferred by Chinese retail investors, which has caused their valuations to move up dramatically.
One area she highlighted was semiconductor manufacturers.
“Due to the fact that the US plans to cut off the semiconductor supply to Huawei or certain Chinese companies, there is a huge push for semiconductor production,” she said.
Other companies that have benefited from retail investors are suppliers to Elon Musk’s electric vehicle company Tesla which, due to restrictions, Chinese investors cannot invest in.
“There are some auto component companies that supply to Tesla, and because of the dramatic rise of Tesla a lot of retail investors have gone into these auto parts companies,” she said.
She highlighted Chinese liquor companies as another area that has been subject to strong retail flows, especially for high-end products.
“In last few years they have risen a lot and the retail investors are always chasing the latest stories, so we have seen a lot of them flocking into the blue-chip liquor names,” the GAM manager said. “These are very good companies, very profitable companies, however the valuations have been pushed to the high end of the historical range.”
Indeed, retail investor crowding can prevent fund managers from buying good companies because the prices have been run-up, with GAM’s Cortesi highlighting Kweichow Moutai Co – a partially state-owned firm and the world’s most valuable liquor company.
“This is a stock we really like, it is an extremely good company, however the valuation has been pushed up and we have gradually reduced the weighting of the stock,” she said.
“As asset valuation goes up, it makes the upside of the stock smaller, and gives it more risk of correction.”
Gordon Fraser, portfolio manager of the £492m BlackRock Emerging Markets fund, has also observed that the Chinese equity market has been inflated by domestic flows, however, does not believe it is overheating yet.
“Authorities have learned valuable lessons from the last domestic share boom in 2015 and have been proactive in controlling the local enthusiasm,” he said. “They have taken measures to prevent over-leveraging of local investors.
“Yet, we do observe a strong narrowness in the market on certain sectors and stocks, which results in a dislocation between earnings and share prices.
“These are centred on ‘aspirational’ stocks which we would define as good stories but with low earnings potential. We are seeing this phenomenon across various markets worldwide, rather than just in Asia or China.”
Despite this, Fraser pointed out that year-to-date, China has been the best performing equity market in the world, with the MSCI China delivering 19.24 per cent year-to-date in sterling terms, compared to the S&P 500’s 8.78 per cent return and the FTSE All Share’s 18.77 per cent loss.
MSCI China versus S&P 500 year-to-date
Source: FE Analytics
Fraser said this is because China came out of the Covid-19 crisis first, and has managed to deliver an ‘impressive’ V-shaped economic recovery.
“From fixed asset investment to industrial outputs via consumer confidence, the Chinese economy has been truly resilient during this turbulent year so far,” he said.
Even after delivering this type of performance, the manager believes valuations are still supportive of levels in Chinese market.
“In our view, despite being towards the top of their historical range, we don’t see Chinese valuations as being stretched – and this is for two reasons,” the BlackRock manager said.
“First, there is a genuine earnings growth story underpinned by strong activity, which we continue to see across many sectors; and second, Chinese valuations started from very low levels reflecting the negatives around US tensions.”
GAM’s Cortesi also believes that overall Chinese valuations aren’t as frothy when compared with the US market.
“A lot of people don’t realise that the MSCI China is the most technology-driven index. It has about 50 per cent in technology and internet related companies,” she said.
She contrasted this to the S&P 500 where technology companies make up roughly one-third of the index.
“If we look at the MSCI China, the P/E [price-to-earnings multiple] is 16.9, whereas the S&P 500 P/E is 25.6. If we look at price to sales, the S&P 500 is at 2.5, MSCI china is at 1.8,” said Cortesi. “So, in China where half of the index is technology and internet related, with a P/E of 16.9, I think that is not too outrageous.”