Graham, the trust’s manager and investment director, outlined the structural problems that still persist in China and the broader Asian sphere, deterring foreign investment.
He explained: “Because it is so easy to raise money through the stock market, a lot of corporates regard the stock market as a piggybank that they can keep coming back to every time they want to raise money. It is a very cheap source of finance, which is a breeding ground for all sorts of bad behaviour.
“It is really easy to find growth in Asia, but it is hard to translate that growth into good returns. There is also the shareholder tax, and if you compound that with the dilution of an increased share base used to fund lazy projects that don’t generate decent returns then it is a ‘double whammy’. That has been a big factor why returns have not done so well.
“It has also been quite an incredibly volatile ride. I bet that the average investor in Asia has not even come close to total return on the market because they tend to get sucked in when everything is good and then get shaken out by a negative surprise.”
However, with the Chinese government demonstrating its commitment to sustained economic growth and structural reform, Graham believes that not only could China see increased foreign investment, but such an influx may be detrimental to India.
“Looking at the accounting policy in China,” he said. “It is not that far away from the financial reporting standards here [in the UK], it is just whether businesses choose to behave within that framework.
“There are really good prices available in India at huge discounts, but to own Indian companies you must believe that high growth and elevated margins will exist for a very long time. Companies go through periods where they don’t grow for a few years, the margins come under pressure and there is the opportunity to buy back.
“There are a lot of companies in India that are no better or worse than Chinese companies, but are trading a lot higher because of the underlying problems in China. But what happens if the Chinese government starts to ease policy more aggressively and profits start to recover? Emerging market managers are not going to take weighting from their already underweight positions in Russia and Latin America – they are going to take it from their Indian overweight.”
Laura Luo, head of Baring Asset Management’s Hong Kong China Fund, foresees a re-rating of the Chinese equity market and improved margins as a result.
“Two factors will lead to a re-rating of China’s equity market,” she said. “The first is the application of a lower risk-free rate by investment analysts, reflecting interest-rate deregulation and rate cuts. The second is a reduced equity risk premium due to deleveraging and progress on reforms.
“Taken together, we believe that Chinese companies justify a higher valuation multiple than they are currently trading on, and we see plenty of scope for this from here, with both price-to-book and forward price-to-earnings multiples well below the historical mean.
“In addition to this, we see room for profit margin expansion at Chinese companies, helped by cheaper raw materials prices including a lower oil price. Reduced financing costs now that interest rates have come down – and may still have further to go – and better corporate cost control in China should also help.”
