You may have noticed that China’s Shanghai Stock Exchange Composite Index has risen more than 45% during the past three months and over 130% in the past year.
More recently, Hong Kong’s Hang Seng Index has joined the party. So what is going on?
There have been two important influences on Chinese stock prices recently. The first is the mutual market access (MMA) programme. Announced a year ago and formally launched last November, this establishes two-way stock-market access between mainland China and Hong Kong.
As a result, Hong Kong investors, and other international investors who trade through Hong Kong, can now buy certain Chinese A-shares that were previously available only to Chinese investors. And conversely, mainland Chinese investors can now buy eligible shares listed on the Hong Kong Stock Exchange.
The second main factor in the rise of the Chinese stock market has been monetary stimulus. Since November 2014, the People’s Bank of China (the central bank) has cut interest rates three times.
It has also announced the second reduction in reserve requirements in two months, freeing up extra money for Chinese banks to lend. Central bank governor Zhou Xiaochuan raised expectations for new measures to support the economy a couple of months ago when he said that China’s growth had slowed “too much”.
While the MMA programme has benefited Hong Kong stock prices, these shares had already been available to a diverse group of international investors. Chinese shares, previously off-limits, have profited more dramatically from the new regime.
For several years, our emerging market strategy has been substantially underweight to China. While this has clearly detracted from performance more recently, there have been important reasons for our caution.
As fundamental, bottom-up investors we have struggled to find Chinese companies that meet our investment criteria.
We look for high-quality companies with good returns on capital, the ability to generate significant cash flows and which have headroom for long-duration growth.
Furthermore, we look for businesses with sustainable competitive advantages; in China’s hyper-competitive business environment, companies can lose their competitive advantages quickly.
Underpinning all this is our focus on valuation.
