On the surface, it is easy to make an optimistic case for China. Its economy has recovered swiftly and the IMF forecasts 8.1% growth for the year ahead. This puts it on track to become the world’s largest economy in 2028. It is increasing its self-reliance, forging ahead with infrastructure building, developing its own innovative technology sector. Year of the bull rather than the ox, perhaps?
Investors are already wise to China’s success: the IA Greater China sector was only beaten by the technology and telecommunications sector in 2020, with the average fund rising 33.5%. Fund selectors report increasing demand for ‘China only’ exposure, rather than more generalised emerging market exposure and China is an increasingly dominant part of the MSCI Asia and Emerging market indices.
China has been on a tear over the past year
James Syme, on the JOHCM Global Emerging Markets Opportunities fund, says certain sectors have been particularly in favour: “The significant boost to gaming, online media consumption and e-commerce from Covid, coupled with strong investor preference for this sector, drove strong performance from these stocks and lifted the overall market higher.”
Equally, the domestic asset management industry was also influential in driving the market. Data from Shanghai Consultancy Z-Ben, reported in the Financial Times, shows new mutual funds launched in China attracted $389bn (£280bn) in 2020, up 90% on 2019. The country’s mutual fund industry grew from $2.1trn to $3.1trn.
Why are some managers shying away from China?
Against this apparently compelling backdrop, why are fund managers backing away? Major emerging market managers such as Devon Kaloo at Aberdeen Standard Investments, Tom Wilson, head of emerging market equities at Schroders, and Syme have all been reducing their China weightings in recent months.
First is a concern over deteriorating economic data. Syme says there are signs of a slowdown in Chinese activity in the last quarter of 2020.
“This is by no means a crisis, but PMI data through the year end came in below consensus expectations, and November retail sales, while up 5% year-on-year, indicated that there has still not been a bounce back in the Chinese consumer to make up for the downturn in the spring,” he says. “These stand in contrast to several other large emerging markets, where data continue to surprise as recoveries come through.”
Shaniel Ramjee (pictured), manager of the newly-launched Pictet Emerging Markets Multi Asset fund, says that the Chinese economy has been supported by Western demand for goods in 2020, but self-sustaining demand for domestic goods and services will need to come through in 2021.
“Will Chinese growth divert to internal growth? How will growth change to become more consumer-driven? We are looking for signs of the economy changing pace,” Ramjee says.
With this in mind, the relative weakness in the Chinese consumer is a cause for concern.
PBC could tighten while Biden poses quiet threat
China may also be the first major economy to tighten monetary policy. Ramjee says: “The People’s Bank of China hasn’t done as much stimulus in 2020. As such, it has the resources and ability to stimulate the economy further. However, there is a chance the PBOC will reduce the level of liquidity over the next year. The ability for liquidity to drive up asset prices may be diminished.”
There are also political challenges. In Joe Biden, the Chinese government may have a less combative adversary, but he is still an adversary. There has been no rolling back of restrictions implemented during the Trump administration, such as those on the use of US semiconductors, or on US investors investing in Chinese state-owned enterprises. China, for its part, has recently announced curbs on rare earth exports in a move designed to cause problems for the US defence industry.
Alibaba saga shows role of government in corporate China
Syme points out that the failed $37bn listing of Ant Group came about because major shareholder and Alibaba founder Jack Ma made a speech criticising Chinese regulators. In December, the state began an antitrust investigation into Alibaba. It demonstrated the role that government still plays in corporate China and the potential risk to markets that poses.
Hugo Robinson, manager of the Arisaig Global Emerging Markets Consumer fund, believes this may not be as important as it first appears. “The government can and does periodically yank on the chain of the internet majors in order to assert its authority,” he says. “Despite this perennial tension, we think the interests of these companies are fundamentally aligned with those of the government.”
Capitalising on the ebb and flow of investor sentiment
None of these would necessarily be problems in themselves, but there is a lot of expectation currently reflected in the price of Chinese shares. The gap between expectation and reality may be more problematic as the rest of the world recovers and Chinese economic strength doesn’t appear as exceptional. The buoyancy of the ‘A’ Shares market isn’t helped by new-found private investor interest in the sector.
Ramjee says: “There are particular sectors that tend to become very popular when the retail sector takes an interest – the technology sector for example. It is part and parcel of investing in China.”
For him, the ebb and flow of investor sentiment can be useful. At the moment, for example, he sees an arbitrage opportunity between the ‘A’ Shares market, which looks expensive and the Hong Kong market, which looks cheaper. “We see the potential for that to normalise, particularly as Hong Kong opens up after lockdown,” he adds.
The Chinese stock market is increasingly large and diverse. As such, it will always hold opportunities. However, investors may need to be more creative than opting for the large index names that have been so popular in recent history. Here, the risks may be mounting.
