- Returning appetite for Emerging Markets with flows beginning to pick up. China A-shares offer a necessary diversification for any allocation made to Chinese equities
- China is a consumption story well represented in the large pool of A-shares
- Financial sector reforms and establishment of greater connections between foreign investors and domestic stock markets
All superlatives have been used and reused to describe China’s size, its fast growing economy and the leading role it is meant to play over the coming decades. While most of those statements are well documented and indeed largely accurate, the Chinese consumption story is too often overlooked or even worse: misunderstood and missed by most active managers and clearly underrepresented in passive vehicles.
China’s consumption story is expanding quickly and the large pool of A-shares is where to find many of the most appealing investment cases. Urbanization and Consumption are the key words in this process. It seems that the market has not yet fully priced in this trend simply because the pace of it comes from the largest urban population in world history. In a context of China bashing, the country could also be perceived as a genuine and contrarian investment case.
A new engine for the Chinese economy, a new consumption culture
The proportion of the population born after the Deng Xiaoping era has just reached the tipping point: it accounted for more than half of the population in 2015. Their ranks should grow to two-thirds in five years and their consumption behaviour is already reshaping China’s political, economic, business and social landscapes.
This generation, born in the 1980s and after, grew up at a time of unprecedented stability and relative prosperity, so they have the confidence and money to spend on their own well-being, personal fulfilment and entertainment.
Urbanization is one of the key drivers of the economic transformation away from heavy industry dominated by State Owned Enterprises (SOEs) to a private sector-led economy driven by domestic consumption, tourism and services.
People often and rightly believe that investing in the stock market requires professional knowledge and experience. It is apparent that to be a long-term winner in China needs local knowledge and experience. The Chinese market is indeed volatile and full of uncertainty but never short of investment opportunities. Even though macroeconomic conditions are weaker than in the past, a hard landing is unlikely. After all, the current situation is a result of a raft of economic reforms, and should not be interpreted as any fundamental slowdown in activity. In the past, secondary industries, especially the real estate sector, were the drivers of domestic growth. Now the reform agenda is meant to enhance the contribution from tertiary industries. According to the statement accompanying the 13th five-year plan, China aims to double its 2010 GDP and per capita income of both urban and rural residents by 2020. As a result, it could deliver a more balanced, inclusive and sustainable development.
Within those reforms, the “new economy” investment cases are emerging as key investment targets for long-term investors. Among others, compelling investment ideas are emerging from national defence, aerospace, new-energy automobile, medical services, information, intelligence concepts and TMT (technology, media and telecom). Essentially, those are the sectors highlighted in the 12th and 13th five-year plans. Even though some of these concepts are quite mature in Western countries, this is not yet the case in China. For active investors, the challenge is to locate the technical knowledge in China and identify the companies and management that can make them profitable. Additional efforts on bottom-up research are the key to exploring investable names and those with potential growth power.
There is an expectation that Chinese equity markets could be volatile in the short run but will gradually resume a normal trend thanks to the winners in the new economy. The lack of confidence amongst market participants on state-owned sectors makes the overall investment sentiment much more short-term. It is better to avoid those volatile sectors with a good example being state-owned banks. Thematic and consumption-led investment cases should dominate positive market movements. As for liquidity, with the mission to complete supply reform in the near future, the Chinese government is unlikely to release a series of monetary or fiscal stimulus polices, but rather maintain a moderate level with open-market operations. This is as a positive environment for the market to regain stability. In the long term, while real estate prices seem set to remain high and bond yields to decrease, equities, especially the undervalued ones in the fast-growing sectors, will continue to offer greater asset allocation advantages than other assets. “New stories” emerging from a growing consumption-led economy will remain the alpha drivers in the markets.
A-shares and H-shares are not equal
H-shares have traditionally been the only access to China for most investors. Today, however, with the opening of the domestic market, A-shares provide an opportunity for investors to broaden their exposure to these faster growing segments within China (51 stocks in the MSCI China Index vs. 338 in the MSCI China A index for Consumer Discretionary, Consumer Staples, Health Care, Information Technology). This is achieved via a subset of companies where it is possible to find ‘better’ companies at a lower price than those selected from only the H-share universe. In addition, it also gives investors the ability to manage risks better around the restructuring of the ‘old economy’ sectors (Industrials, Materials, Energy, Financials, etc.) with 480 potential names to choose from in these sectors in the A-share market compared to just 97 in the H-share market. Within the A-shares universe, investors can find segments of the economy which are almost impossible to invest in if restricted to Hong-Kong listed stocks.
2016 shows evidence of a turnaround year not only for the Chinese economy but also for financial market deregulation and Chinese equities. A-shares provide investors with diversification in their Chinese allocation but also access to a larger pool of investment opportunities. Many of them are closely linked to the economic transformation of China. China’s consumption story will continue to develop and provide experienced managers with market inefficiencies to exploit.
Fund Manager - Asian Equities