“Is now the time for Chinese equities?” asks one, “China has changed out of all recognition” says another, “Chinese economy to grow faster in 2013” predicts yet another.
But the vital point all of these commentators fail to mention is that in the final quarter of 2012 the IMA China and Greater China Sector was the best-performing sector, gaining 10.59% in the period.
On top of this – and given that many advisers choose to gain clients’ exposure to China through GEM funds – F&C’s data showing the IMA Global Emerging Markets Sector as the most consistent sector for top quartile returns in Q4 2012 is also due some consideration.
F&C’s Consistency Ratio looks at the proportion of funds in the 12 main IMA sectors that have performed consistently above average in each of the past three 12-month periods. Its Q4 results showed 17% of IMA GEM Sector funds met this target, with the Asia ex-Japan Sector second in line with only 8% of funds achieving top quartile returns over the three discrete years.
Traditionally core sectors, such as UK Equity and US Equity, were by implication nowhere near the GEM sector in terms of consistency.
Easy money made?
Does this mean investors have missed the boat when it comes to generating significant returns from Chinese equities and/or GEM funds? And if they listen to all the buzz about the country coinciding with its new year will they simply be chasing the dragon and thus finding returns as slippery as a snake (being the year of the snake)?
Not if valuations are to be believed.
In 2007 optimism about China’s prospects was at its peak, according to M&G’s Global Emerging Markets Fund manager Matthew Vaight, and the stock market was riding high, with many investors’ fear of missing out on great potential returns outweighing worries about risks of investing in the country.
“Investors got carried away and we were in ‘bubble’ territory. At the market’s peak valuations implied that the average Chinese company was going to grow by 28% per annum for the next decade. This was clearly highly unlikely.
“Today you could argue investors have fallen out of love with China. Valuations have fallen accordingly and the stock market is currently implying future growth of 4% per annum. Given the golden rule of successful investing, namely to buy assets when they are cheap, we believe that right now Chinese equities are worth a closer look.”
Cheap as chips
He warns, however, that cheap companies are not necessarily good companies and metrics such as return on capital and corporate governance must also be weighted up.
“The reputation of Chinese companies in these areas has not always been impressive, so while the Chinese market arguably looks good value, investors have to be selective in finding companies that are well managed, focusing on profitability and generating returns for their shareholders,” Vaight said.
Senior research analyst at Bestinvest, Ben Seager-Scott agrees the investment case for China is mixed.
“China is looking cheap compared to its own history, which many take as a sign of an attractive entry point for investment. But you should bear in mind that growth rates are also more subdued, which could mean lower values are justified, and could fall further.
“On top of this, there are growing concerns about an often-overlooked distinction between real and nominal growth rates. Finally, Chinese opacity might come back to bite investors in the guise of the shadow-banking system, which has been meeting financing and credit/debt demands where the banks have been ordered to cut back lending.”
Neutral approach
On balance Seager-Scott said those with a nearer-term focus could hear sound arguments on both the positive and negative side of Chinese equities, which has led him to take a neutral outlook on the stock market at present.
Such a considered approach to China is welcome in the sea of bullish views which have poured out of the region recently.
In much the same way investors are cautious of the general equity rally we have seen since the start of the year, a measure of restraint seems to be called for in China. The last thing you want is to bitten by the snake.
