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The case builds for China A-shares
The China growth story is well known to international investors but the best way to access profitable growth and the various risks continue to evolve as part of that story.
In a session devoted to ‘Investing for Change in China A-Shares’ at last week’s JANA annual conference (September 16), Wenchang Ma, Hong Kong-based portfolio manager for Ninety One, said that the international allocation to China by investors was still in its early stages and that China A-shares represented a unique opportunity to catch the growth trend.
“China offers a rich pool of opportunities in what is the world’s second-largest market,” she said. For example, there were about 800 A-shares with market caps of more than US$2 billion, trading at an average of 12.8 times forward P:Es compared with 628 US companies with market caps of at least US$2 billion, and generally significantly larger, but trading at 19 times forward P:Es.
“The number of Chinese companies in that category is expected to increase, suggesting substantial return upside, even if they only go half-way to making up the difference,” she said.
In her view there were three main drivers of future growth. They were:
- Innovation. The level of productivity still has a lot of room for improvement and China’s spending on R&D has already risen to be on par with most western countries, at 2.4 per cent of GDP, not far behind America’s 3 per cent. China leads the world in the number of patent filings although it lags the top tier in patents granted. There is an increasing amount of research going into the important natural sciences.
- Expansion of the middle class. There are currently 280 million people in China with annual incomes about US$10,000, a figure which is expected to rise to 680 million by 2030. The Chinese consumer market is already twice the size of Japan’s in value.
- Continued efforts to reform, open up the economy. “China has been driving reforms for some time,” Wenchang said. “There were the anti-corruption and supply-side reforms of 2012 and 2015, and real estate more recently. The Government is addressing the pain points. There was Stock Connect of 2014-15 opening up investment and more foreign ownership limits removed. Last year there was the pledge to be carbon neutral by 2060.”
The China A-shares market was an evolving landscape,” Wenchang said. “After 40 years of a market economy, there were now many new secondary listings coming on. The structure of the [China A-shares] market has changed,” she said.
“In 2010, old economy stocks such as financials and energy made up 80 per cent of the market and state-owned enterprises dominated. Now that’s only about half the market and the new economy, such as health care, IT and consumer staples make up about half.”
A-shares were also attractive because of the inefficiency of the market. Retail investors made up about 50 per cent of the free-flow market capitalization and foreign investors were still only in the single digits as a percentage of the market ownership. This compared with 15 per cent in the US, 30 per cent in Japan and 55 per cent in the UK.
Chinese retail invested were susceptible to “herding” and tended to participate in a small number of crowded trades, she said, providing more opportunities for professional fund managers.
The risks associated with the Chinese market were also evolving. The geopolitical risks remain a concern, however, they also presented opportunities. Foreign investors could limit exposures to geopolitical risks by concentrating on the Chinese domestic market and supply chain companies.
ESG risks, which were traditionally the other major concern, also remained but there had been significant improvements in recent years.
“The key to mitigating ESG risks is through active management and engagement, which requires local expertise” Wenchang said. “What we see are continuing strong growth engines with attractive valuations. It’s a rich pool of opportunities for alpha generation.
Stuart Rae, the Melbourne-based CIO for Asia Pacific value equities at Alliance Bernstein, who also spoke on China A-shares at the conference, emphasised the importance of the ‘Dual Circulation Concept’ put forward by China’s Politburo in the middle of last year.
This recognizes the long-term economic and technological rivalry with the US and that it is “unsustainable” for China to continue to rely upon overseas demand as it does, resulting in a repositioning of exports and greater demand at home along with technological self-reliance.
“You need to be active to take advantage of the opportunities because valuations are very different across the economy,” he said. “New economy valuations are high but not everything that’s cheap is good value, either.”
He also said that some of the risks often cited with China were “overstated”. Capital repatriation, for instance, was not a risk that was confined to China, which had had fewer examples of this than many other countries.
Also, the suspension of certain stocks, which had become a problem in 2015, was less of a risk now because China had learned from its experience.
On whether SOEs were too risky because they might not be run for all shareholders, he said it was probably true that POEs (privately owned enterprises) had higher profitability and less leverage, but the difference was not as great as sometimes assumed.
“And you can pick and choose between them,” he said. The key is in being selective.”
In another Chinese market development announced early this month (September 2), the President, Xi Jinping, said Beijing was to be the home for the country’s third stock market.
His announcement took market observers by surprise, since it had not been mentioned in policy blueprints, and details were initially scant. The new exchange will complement the main Shanghai exchange and the tech-orientated Shenzhen exchange, likely concentrating on the small end of the market (see separate report this edition).
