Are investors still underestimating China?

China is under owned by international investors, but that could gradually change. Rob Morgan looks at some investment options in the area.

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  1. Rob Morgan

When the news of the Covid-19 virus was first breaking in Wuhan, investors could be forgiven for thinking Chinese shares would be among the worst hit globally. Fast forward to today and it’s a very different picture. Despite being the initial epicentre, it turned out that China was better equipped than most countries to deal with Covid-19, with its ability to implement tight controls on its population. This seems to have allowed it to reach the other side far quicker than western countries still grappling with the outbreak.

The evolution of the Chinese economy to being more domestically driven has also helped shield it from some of the economic impact of a global slow-down, as has the growing influence of more resilient business models in the technology and healthcare sectors. The world’s second largest economy has the top performing major stock market in 2020 to date with gains of over 20%.

China will lead the world economic recovery this year with the latest third-quarter figures indicating modest growth for 2020. The resumption of a high growth rate next year seems likely. President Xi has adopted a new approach to China’s development to tackle the twin problems of Western resistance to the Chinese trading model and the continuing negative impact of the pandemic on western economies. He calls for a ‘dual circulation’ economy to reduce China’s dependence on exports overseas, foster more domestic consumption and encourage domestic technology development.

A complex investment area…

Historically, UK investors have often taken Chinese exposure through broad global emerging markets or Asian equity funds. Yet with the growing influence of the Chinese economy and the opening of its onshore equity market, the case for a dedicated Chinese allocation in portfolios to harness this huge market is growing.

Allocating to Chinese equities on a standalone basis sounds simple enough, but the reality is less straightforward due to the many types of listings a Chinese company can have. ‘A shares’ are incorporated in China and trade on the Shanghai and Shenzhen exchanges quoted in local renminbi, whereas ‘B shares’ are quoted in foreign currencies. Meanwhile, ‘Red chips’ and ‘P chips’ are incorporated outside of China and trade on the Hong Kong exchange. Red chips are usually controlled by the state or a province or municipality, whereas P chips are non-state-owned Chinese companies. Many funds investing in the area also include Taiwanese-listed companies in their opportunity set.

…and one often overlooked

China has established itself as one of the great sources of innovation globally and a variety of companies are riding this wave. Yet the returns on offer seemed to have been overlooked by many. As research from Baillie Gifford points out, China is significantly underrepresented in global portfolios: globally, China is 18% of market capitalisation, 30% of listed stocks, but only 2.5% of global funds’ allocations. These figures are from last year and the influence of Chinese stocks has only grown since.

Yet the lack of ownership of Chinese equities among non-local investors is beginning to change. The growing prominence of Chinese equities in key indexes such as MSCI AC World has started to result in greater investors flows, largely driven by the gradual inclusion of Chinese ‘A’ shares, which until 2018 didn’t form part of global indices at all.

China has also risen in prominence among Emerging Markets indices. In 2010, China represented 17% of the MSCI Emerging Markets Index, today it is 40%, with a further 10% accounted for by Taiwan. As such institutional investors are having to progressively focus more on China, and international investment flows into the area from are likely to remain on an upward trajectory.

Investment options

The sheer size of its capital markets means that China demands considerable attention from investors. Specialist standalone exposure is worth considering as part of a broad portfolio in order to harness the skills of leading managers or to focus on important trends in the region. Here are some options our Collectives Research Team have identified as worth considering. Please note that China is considered an emerging market so the risks can be higher compared with developed markets, plus the extent of volatility, or market ‘ups and downs’, can be greater.

First Sentier (formerly First State) Greater China Growth

The depth and breadth of the opportunity set across the region should offer favourable conditions to good active managers. One option for navigating the complexities and gaining access to opportunities in China’s growth story is First Sentier Greater China Growth. The fund invests in high-quality businesses in China, Hong Kong and Taiwan with the manager prioritising well-run businesses that can deliver consistent growth in earnings over time.

Asian equity veteran Martin Lau has been the fund’s lead manager since its 2003 launch and has been successful in keeping up with the dynamic and evolving markets. He can draw upon a large Asian equity team based out of Hong Kong and Singapore.

Find out more including Key Investor Information Document

Fidelity China Special Situations

This represents a higher risk option within the area, with significant concentration at the stock level and gearing (borrowing to invest) of around 25%, which exacerbates the gains and losses on the underlying portfolio. Recent strong performance has been powered by large holdings in internet giants Tencent and Alibaba as well as several consumer stocks aligned with the growth of China’s middle classes.

Manager Dale Nicholls makes full use of the investment trust flexibility. He will gear when deemed appropriate but also take short positions (to benefit from falls) in single companies and indices. The trust also invests in private companies (to a maximum of 10% of net asset value) with Bytedance (owner of TikTok) being a recent recognisable example. Unlike the First Sentier fund, it is benchmarked against the MSCI China, so it doesn’t come with a significant Taiwanese weighting and therefore represents more a ‘domestic’ Chinese investment.

Find out more including Key Information Document

KraneShares CSI China Internet UCITS ETF

This ETF (Exchange Traded Fund) from KraneShares tracks 31 Chinese internet stocks. It could be worth considering by more adventurous investors looking for a specialist holding that covers a basket of these names including Alibaba, Tencent and Baidu as well as lesser known ones such as e-commerce platform Pinduoduo.

The ETF covers companies that develop and market internet software and/or provide Internet services, manufacture home entertainment or educational software for home use, provide retail or commercial services primarily through the internet; and develop and market mobile internet software and/or provide mobile internet services.

The annual charge is high for an index-tracker product at 0.75%, but it is the only one of its kind available in Europe. Owing to narrow investment universe and the considerable volatility of the underlying holdings this should be considered a very high risk and niche investment. An example of an ETF for broader exposure to the Chinese market is HSBC MSCI China UCITS, which aims to track an index of over 750 companies across China – including H shares, B shares, Red chips, P chips, US ADRs and a new inclusion of large and mid-cap China A mainland companies. 

Find out more including Key Investor Information Document

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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