Much of the discussion about China in investment circles has been dominated by its trade war with the US and the recent emergence of the Wuhan coronavirus. However, many of the long-term drivers of the Chinese market remain intact despite the uncertainty caused by these events. 
With Saturday 25 January marking the beginning of the Chinese Year of the Rat, seen as a sign of wealth and surplus, Trustnet asked fund managers what investors need to know about China and emerging opportunities to take advantage of.
Ian Hargreaves, co-head of Asian and emerging market equities at Invesco, said while China’s economy appears relatively robust – trade war with the US, notwithstanding – the broader trend has been one of steadily slowing growth, in large part due to tighter policy from authorities in the past couple of years as debt levels spiralled.
“The authorities appear to remain focused on striking a delicate balance between maintaining an acceptable level of economic growth whilst managing financial risks in the economy,” he explained. “As such, we do not expect them to ease aggressively.
“However, the lagged impact of previous policy tightening on economic output is dissipating and China’s growth should stabilise in the medium term helped by supportive economic policies.”
Source: International Monetary Fund
Hargreaves said Invesco has not been bullish on a top-down view on the country for some time but has seen some longer-term opportunities in sectors such as automobiles and beverages, and had existing holdings in cash-generative internet companies.
More consumer spending is likely to benefit such sectors and is one of the longer-term demographic trends that has emerged in China, with the rise of the middle class.
Consumer discretionary stocks have benefited given the Chinese public’s “voracious appetite for everything from luxury bags and travel to premium food and elite education”, according to Alliance Trust portfolio manager Rajiv Jain.
The portfolio manager said there is likely to be further opportunities due to the differentiation within the group itself, with the emergence of upper- and lower-middle classes.
Consumption by the upper-middle class and high net worth individuals is likely to be unaffected by any economic downturn, said Jain, “as their wealth is large enough to navigate any weakness”.
Source: International Monetary Fund
Meanwhile, the lower-middle classes – where spending is more reliant on pay checks – could bear the brunt of any downturn as was seen more recently when more people chose to take domestic or regional holidays rather than trips to Europe or the US.
“On both sides, looking into the sector-specifics and at the fundamentals of companies that have differentiated product offerings will be important in order to capture these different dynamics, and take advantage of the changing consumer trends we are now witnessing in China,” said the manager.
The emergence of the Chinese consumer is a theme that David Coombs, manager of the Rathbone Multi Asset Portfolio funds, is also monitoring as the economy has moved away from heavy industry to private enterprise, services and consumption.
“This shift has been remarkable but there’s a lot of road for this growth to continue. Chinese e-commerce blows many Western attempts out of the water,” said Coombs. “For us, the Chinese consumer is where we want to be focusing over the longer-term, rather than the China of old.”
While developed market investors have traditionally accessed China through large multi-nationals that sell into the country, this approach has been stymied by the emergence of local competitors.
“The best multi-nationals who sell into China tend to have a management team on the ground in China who are able to make the key decisions around business strategy and products sold and launched in the region,” he explained.
“It’s only through action like this that these large multi-nationals can stop being disrupted by local competition who know their market inside and out.”
Nevertheless, Coombs said that while there are clear challenges to Chinese economic development, current investor allocations to the country are too small.
“China is clearly not without its problems with corporate governance below par, high levels of debt and economic data that can be open to question,” he said. “However, we believe China is really only getting started; the next decade and more will see it soar yet higher.
“This is a huge market to ignore and doing so could hurt investors over the coming years.”
This may change with the recent increase in the weighting of Chinese stocks in the MSCI Emerging Markets index and the opening up of the domestic exchanges to international investors, said T. Rowe Price regional portfolio manager Wenli Zheng.
“Foreign participation in China’s onshore A share market is still only at a low single-digit level, about 3 per cent, even after inclusion in the key MSCI indices,” said Zheng.
“Over the longer term, we are confident international investors and fund managers will not wish to fall so far behind China’s new and rising benchmark weightings and will reposition China mandates accordingly.”
The portfolio manager said foreign ownership levels of 3 per cent look anomalous and out-of-line with other Asian markets – such as Taiwan and South Korea – which are around 40 per cent foreign-owned.
An influx of international investors will help make the domestic markets more efficient and reduce the dominance of retail investors, said Zheng, and at current valuations investors should find some potential upside.
Performance of MSCI China A index over 10yrs
Source: FE Analytics
The manager added: “Valuations in China have fallen significantly since 2015/2016. Even after the rebound in 2019, China A-shares are still at very attractive levels.
“The market is trading below its post-2005 historical mean in terms of trailing and forward P/E [price-to-earnings] ratio, something applying to few other major stock markets today.”