Guinness Greater China managers Edmund Harriss and Sharukh Malik rejected narratives that the Chinese economy could be about to “keel over” due to a property bubble burst, with the duo exploring opportunities in electric vehicle manufacturing and consumer income within the country.
“If you go through an active approach to looking for high-quality compounding companies, [China] is a very interesting opportunity,” Malik told an audience at a Guinness Global Investors investor conference in London last week (26 September).
“To put it another way, if these companies were European or American, you would absolutely love them. But because they’re China, they’re getting that macro discount.”
Is China’s financial system ‘teetering’?
Addressing the macro situation in China, Guinness head of Asian and emerging market investments Edmund Harriss said the property sector had become an outsized share of the country’s GDP, with the government now attempting to cut its economic dependency on real estate.
The sector currently accounts for around 20% of China’s GDP and 23% of capital investments, according to the firm.
He said: “The narrative has focused on the weakness in China’s real estate sector, the debt that has accumulated alongside it, and as that begins to wind down and unravel, the question is now whether China’s financial system is strong enough to cope with it.
“The inference that has been left in much of the public narrative, by people who probably ought to know better, has been that China’s financial system is teetering. Now, given China’s importance to the global economy is large – it is plugged in – this is something that is more than a matter of just polite interest for every global portfolio and asset class. If China’s financial system is about to keel over, it is going to affect you.”
China holds roughly $3trn in foreign exchange reserves, up from $200bn 20 years ago. Harriss said this is a result of China’s economic success.
“As an export manufacturer, it is held predominantly in dollars and in euros in the form of government blocks. If China’s financial system keels over, the first thing they’re going to do is sell those bonds, repatriate the capital, and that is going to depress bond prices, raise yields and remove a significant marginal buyer of government debt, as Europe and US continue to borrow and fund their current account deficits.”
He added: “I promise you, the more you shake that tree, the more robust China’s financial system looks. It can absorb this change, and there are in fact very dynamic areas in China’s economy which we structure our investment strategy around. We think these will deliver earnings growth for the next few years, far in excess of previous averages. And, if you think that valuations have been driven to low levels because of a [certain] scenario, which in fact is unlikely, then you may even think China is an investment opportunity.”
Second economic transition
Harriss added that, if China’s financial system is strong enough to “at least” cope with the property crash, investors “need to move on and think about where the problems lie in China and where the opportunities lie”.
“China is in the process of a second economic transition. This property slowdown has been engineered by the government. It’s part of this economic transition and the reason behind it is this demographic challenge,” he explained.
According to data from the United Nations department of economic and social affairs, China’s labour force is shrinking, with roughly 25% of its population projected to be aged 65 and over by 2040.
As a result of the aging workforce, China is aiming to move into more productive areas of growth than real estate to support a higher level of retirees.
Harriss continued: “China is looking at core pillar industries to dominate over the next few years, sectors such as electric vehicles and industrial automation.”
Allocation
In terms of opportunities, co-manager Sharukh Malik said:“We are targeting the structural growth drivers in China. In our Greater China Fund, we do have exposure to the energy transition electric vehicles. We also have exposure to the rising consumer incomes in China, as China starts making more of its cars and starts exporting more of its solar products, consumer incomes are going to increase and the Chinese consumer-facing firms are likely to do well there.”
“We actually have very little exposure to your real estate, and to banks, the areas which are dominating the narrative,” he added.
According to FE Fundinfo data, the Guinness Greater China strategy ranks fifth out of the 58 funds within the IA China/Greater China sector over three years. In that time, it is down 12.2%, comparing favourably to the sector average 27.7%.
Malik added: “If you look at the market to the MSCI China index, despite all of the economic growth over the past decade, earnings have actually contracted. So yes, you’ll see your stories about the poor earnings growth offered in China. That is only if you go through the passive approach.
