Chinese equities
19 Sep 2019

Don’t be distracted from China’s enduring qualities

China’s vast economy, its emphasis on high-quality growth and recent policy reforms should generate good opportunities for investors.

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China’s vast economy, policy reforms and emphasis on higher value growth offer abundant opportunities for equity investors, even with the backdrop of a US trade war, writes Vincent Che, portfolio manager of the Merian China Equity Fund. 

China’s recent shift in focus from rapid growth driven by fixed-asset investment and cheap manufacturing, towards a more sustainable, high-quality economic expansion is aimed at improving living standards and boosting efficiency. It should also provide opportunities for investors.

The country has undergone rapid social and economic development since market reforms were introduced in 1978, with GDP growth averaging around 10% a year, the fastest sustained expansion by a major economy in history, according to the World Bank.

The demographics of Asia’s largest economy remain attractive, with a population of 1.4 billion, increasingly urbanized, and a growing middle class. China’s GDP per capita of around $10k, lags that of many developed countries and highlights the considerable upside in the value chain.

The government’s Five-Year Plan to 2020 targets 6.5% annual growth– still robust by global standards. The country is moving toward a more consumer- and services led economy with cleaner energy and industry. The government has initiated structural reforms, including changes to state-owned enterprises and moves to encourage innovation and more open markets.

The trade war undoubtedly throws up challenges. We see it as a potential medium- to long-term headwind that will generate additional periods of market volatility. We estimate the additional US tariffs may reduce China exports in the low single-digit percentage. While there may be some single-issue agreements, an accord on intellectual property may be more unlikely in the short term.

China economic data in the year through June was mainly on track but there were signals of downward pressure related to trade. Policymakers announced fiscal and monetary measures including VAT changes and cuts in the reserve requirement ratio for banks in an effort to boost lending.

We expect the government to use reforms, stimulus and its considerable fiscal resources as a safety net to stabilize the economy and protect growth. Policymakers are likely to provide additional stimulus in the second half of the year in the form of rate cuts, looser rules on infrastructure spending.

China is keen to attract international capital and has begun to speed the opening of financial services to foreign companies.  The securities regulator has modified rules to allow international financial firms to become majority owners of local joint ventures. Goldman Sachs, JPMorgan and Credit Suisse are among the international banks that have applied to increase the ownership of their Chinese JVs.

Another reform is the Stock Connect program, collaboration between the Hong Kong, Shanghai and Shenzhen exchanges, which allows international and mainland Chinese investors to trade securities in each other’s markets through their home exchange.

As part of a program called Shanghai-London Stock Connect, Huatai Securities raised $1.54bln in July, becoming the first issuer to list GDRs in London on the Shanghai Segment of the London Stock Exchange.

We believe China assets become more attractive as the economy moves into a period of quality growth. We see potential for higher returns on equity and increased revenue growth as capital expenditure requirements ease. This should lead to improved cash flow and dividends.

In the Merian China Equity Fund we are currently focused on companies with strong fundamentals in the consumer, healthcare, utility and financials sectors, as well as trading opportunities in the materials and industrial sectors.

Trade war or not, we believe the China  growth story remains intact, that less restrictive government policy is the trend and that current valuation levels make Chinese stocks more attractive.  We see good opportunities for longer term investors who are seeking an entry point to Chinese equities.