The latest headlines on investing in China essentially reflect a simple “bull vs. bear” debate. As valuations decrease in the face of what is perceived to be growing potential risks, “buy or sell China?” is the question on many global investors’ minds.
But as economic realities have evolved, this binary approach is quickly becoming an outdated debate.
The more relevant question facing investors is how to invest in China, not when, or if. This is because viewing China as a distinct asset class may be a more effective long-term approach to capitalising on the country’s growth.
Investment strategy always matters. However, choice of strategy is still a new concept when applied to China. The commitment to a geographic area as a strategic and permanent part of a portfolio implies that more consideration be made to the strategy employed there.
The time for that consideration in China is now. It’s a market that now offers opportunities beyond traditional growth plays, for those seeking income via dividends, or pursuing the rapidly expanding universe of smaller companies.
Until now China has been a peripheral part of many global portfolios – of interest in a short-term, tactical sense. During periods of slowing global growth, such as the current environment, exposure to China is reduced if not eliminated.
Down but not out
It is evident China’s growth has moderated, and may do so further in the face of recent global economic weakness. However, these short-term challenges do not negate the reasons for considering China as a separate and distinct asset class.
China’s contribution to GDP is 9% of the world’s economic activity (compared to the US at 23%). Many projections show China is likely to become a bigger part of global economic activity than the US, or the whole of Europe in the future.
Notably for investors, China’s equity universe is diverse. A multitude of new listings lifted the combined market capitalisation for its domestic exchanges to US$3.8 trillion at the end of June 2011, up dramatically from US$402 billion at the end of 2005. Hong Kong’s total stock market capitalization grew from US$1.1 trillion in 2005 to US$2.6 trillion at the end of June 2011, of which mainland Chinese companies account for half.
The size of an economy alone is not sufficient to declare it an asset class, however. Prospects for growth are key. Here, China stands out. Its growth has come from increased total factor productivity (TFP)—the ingenuity with which inputs of labour and capital are combined. China’s rate of TFP growth, above 4%, far exceeds that of Western economies and Japan.
New opportunities
This quality growth has been achieved in a diverse range of industries. China now boasts not only the world’s largest automobile market but also an economy in which new consumer tastes are emerging and creating new opportunities for smaller and more nimble companies in areas such as luxury goods retail and fast food chains.
Investors in China, particularly those focused on short-term capital appreciation, are often oblivious to the income generated by Chinese stocks. Dividends act as a way to extract tangible value from investments and, reinvested, account for over two-thirds of the total returns from Chinese stocks over the last 20 years.
Chinese stocks have also offered competitive dividend yields relative to the US, Japan and Europe. During times of slowing growth, these yields can offer investors the incentive to stay invested and can potentially exhibit less volatility than “growth” stocks.
While China’s growth will meet periods of moderation, this does not warrant exiting Chinese stocks entirely. Rather, it is an opportunity to adopt strategies for better approaches to China that suit investors’ long-term goals.
Henry Zhang is a portfolio manager at Matthews International Capital Management
