One way to harness growth in China

With the growing influence of the Chinese economy and the opening up of its onshore equity market the case for dedicated Chinese allocation in portfolios is growing.

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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 well equipped to deal with Covid-19, with its ability to implement tight controls on its population allowing 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 picture elsewhere in emerging markets has mostly been very different. A number of the smaller nations such as Vietnam have had success in controlling the outbreak, but big index constituents India, Russia and Brazil have been among the worst affected.

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 up 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.

An investment option for expsoure

One option for navigating these complexities and gaining access to opportunities in China’s growth story is First State 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 opportunity set. He can draw upon First State’s large Asian equity team based out of Hong Kong and Singapore.

Having previously eschewed many of the companies listed on China’s domestic A share market, the managers are finding a disproportionate number of new ideas are coming from here. Presently, it accounts for around 15% of the portfolio and they expect exposure to grow over time.

Having experienced a strong 2019 in both relative and absolute terms, the first few months of 2020 was slightly disappointing for the managers. Given their focus on quality they are accustomed to the fund outperforming in falling markets, which wasn’t the case this time round. The fund’s exposure to manufacturing struggled and its underweight position in some big index weightings in the IT sector hurt on a relative basis. The fund recovered well in second quarter, however, and the managers took the opportunity to trim some of the manufacturing exposure in favour of healthcare and IT where positions in Luye Pharma Group and E-Commerce giant JD.com were both initiated.

Technology makes up a substantial proportion of the Chinese markets and the fund’s largest position is internet giant Tencent. However, at around 7% of the fund this is actually only around half of the stock’s weight in the MSCI China Index. In addition, the fund contains no exposure to e-commerce behemoth Alibaba, a strong performer of late, which accounts for a remarkable 18% of that benchmark. Tech exposure is instead maintained through Taiwan Semiconductor, and the inclusion of Taiwanese and Hong Kong-listed stocks that means the fund’s relevant benchmark is the broader MSCI Golden Dragon where the weights of Alibaba and Tencent are a more moderate 11% and 10% respectively.

Our view

Beyond the well-known larger companies, it is the team’s ability to uncover the lesser known names in the region that attracts us to the fund. The portfolio of around 50 holdings strikes a balance between conviction and diversification, and the managers appear well positioned to continue building on the fund’s long-term record of outperformance by harnessing First State’s best ideas across the various Chinese markets. It should appeal to investors drawn to the dynamism of the region and welcome a stringent approach to company quality that has historically added value.

The fund is managed using a long-established and successful investment process looking for well managed companies that look after the interests of minority shareholders. There is a strong emphasis on long term investment decisions and capital preservation; though it is inevitably still a volatile area to invest and should only represent a small component of more adventurous portfolios. We continue to admire the managers’ rigid focus on identifying high-quality companies with trustworthy management in a region where there are many pitfalls for investors. It remains part of our Foundation Fundlist.

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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