Conal Gregory: There's plenty to bark about as China enters the year of the dog
Yesterday China celebrated its new year by lighting fireworks, giving red envelopes of money to children and enjoying celebratory meals to usher in the Year of the Dog.
Dogs are said to be loyal, independent and communicative.
In a survey of fund managers by the Association of Investment Companies, a key theme was optimism despite the recent volatility.
“With valuations still at reasonable levels after the rally last year, we believe structural growth in businesses should drive re-rating this year and beyond,” says Ayaz Ebrahim, portfolio manager of JP Morgan Asian Investment Trust. He tips the consumer, healthcare and technology sectors.
The last 12 months have certainly been a rollercoaster for shareholders in China. The Shanghai SE Composite index has oscillated between 3,016-3,587 whilst the Hang Seng has moved between 23,438-33,484.
The former is based on all companies quoted whilst the latter follows the leading 50 shares. Such a variation shows the importance of timing and why saving regularly gains in the long run rather than to guess the market with lump sums.
The Chinese stock market did very well in 2017. The MSCI China Index posted a gain of almost 40 per cent, driven largely by technology stocks and those linked to the consumer. With a population of around 1.4 billion – more than four times the US – and around 400m millennials making up to 40 per cent of their purchases online, the future looks exciting.
For those who invest in an exchange traded fund or similar low cost tracker which follows an index, China will receive a boost in May when around 200 of its A share-listed companies will be added to the MSCI Emerging Market index. This is the most important index for the sector with an estimated US$1,600bn funds using it as a benchmark.
Whilst China is such a key player in the world economy, it is essentially an emerging market. In such territories, it is best to seek regions with the most credible macroeconomic policies, where structural growth and governance are strongest and markets are most liquid and diversified.
“Emerging Asia is still the region that most readily ticks these boxes for us with China among our preferred country specific equity exposures,” says Nick Keenan, director of Wealth Management for Barclays.
He believes the fundamental prospects for China’s retail sector, particularly in e-commerce firms, “remain bright”, notably boosted by a still expanding middle class at the centre of this consumption story.
The marathon address by Xi Jinping at the party congress in October laid the foundation for the economy, reform, environment and quality of life to be expected until 2050.
“At the heart of this address was a focus on sustainable growth with almost Trump-like soundbites such as Beautiful China and Made in China while it was clear the country will raise its profile on the international stage,” says Michael Kerley, manager of Henderson Far East Income.
Although GDP growth – 6.9 per cent in 2017, above Beijing’s target of 6.5 per cent – will remain robust, this will now not be the main target of government policy with the quality and sustainability of growth more important than the quantum. Kerley says this should provide opportunities “to invest in some very attractive companies”.
Darius McDermott of Chelsea Financial Services is excited by China’s e-commerce businesses like Alibaba. He says: “Tencent – think Facebook, Just Eat, Uber and Paypal all rolled into one company – is another business that is cashing in on the growing digital consumer spend. One of its businesses, TenPay, together with Alipay, are responsible for over 90 per cent of e-payments in China.”
Since regulatory restrictions make it difficult for Western tech giants to gain ground, letting local brands seize the chance. McDermott tips Fidelity China Special Situations, First State Greater China Growth and Invesco Perpetual Hong Kong and China.
The extent of economic growth is demonstrated in the population changes with 40 per cent living in developed urban areas in 2004 and today around 60 per cent.
Elizabeth Hastings, chartered financial planner at advisers Chase de Vere in Leeds, says there are is an abundant supply of university graduates who are paid significantly less than their peers elsewhere, meaning the Chinese benefit from a highly educated but quite cheap labour force.
From an investment perspective, this has created a clear divergence between the old economy stocks which invest in energy, materials and industrials and new economy ones which include IT, healthcare and consumer goods and services.
China is the manufacturing hub of the globe, making it the largest consumer of raw materials including over 30 per cent of base metals.
However, there are some concerns about China. Keenan cites the housing market which is again showing signs of slowing although the authorities have the means to correct the problem whilst continuing to rebalance the economy at an orderly pace.
McDermott is worried by China’s massive debt as well as housing. The banking system with ownership mostly controlled by the state troubles Hastings who says that, with the very high debt levels, very careful management will be required to avoid imploding at some point.
Observers are also aware of the US administration’s planned protectionism and tension from North Korea.
Andy Parsons, head of investments at The Share Centre, says that growth in China “appears to be stabilising and its economy avoiding a hard landing”. He would limit exposure over levels of corporate debt and bank lending.
Carolyn Black, associate director at investment managers Myddleton Croft, prefers to gain exposure to China through a diversified Asian fund and commends the Schroder Asian Income Maximiser with 16 per cent held in large Chinese corporate.
Until late last year, the firm also owned Schroder Asian Total Return trust which has Chinese exposure close to 32 per cent.
Hastings says that whilst investors should have some exposure to China, because of the high risks, she does not recommend any specific Chinese funds, instead suggesting broad-based emerging market collectives.
Two favoured funds are JP Morgan Emerging Markets and Fidelity Emerging Markets with 35 and 20 per cent respectively invested in China.
Much of the growth cannot be accessed by Chinese companies as it is “directed according to political rather than shareholder objectives and this is unlikely to change in the foreseeable future”, warns Jason Hollands of Tilney.
He suggests investing through Schroder Asian Alpha Plus which has 30.2 per cent in mainland China and an additional 20.3 per cent in Hong Kong stocks, Fidelity Emerging Markets or First State Asia Focus.
Finally, look at any borrowing undertaken by a fund. Seven Investment Management rates Fidelity China Special Situations highly but says that its 26 per cent borrowing could be a turbo boost if Chinese markets continue to rise but will act as a significant drag if the market goes the other way.