A contrarian bet on Chinese tech stocks has paid off for Lazard Asset Management’s James Donald and the firm’s emerging market equity strategy this year.
Throughout most of the 2010s, the top-ranked quality value manager saw performance lag as he refused to pay up for Chinese tech giants trading at high valuations.
But just as investors showed signs of capitulation on Chinese stocks, Donald (pictured) and his team started buying up Chinese tech names towards the tail end of 2023, reaching an overweight to China for the first time in decades towards the end of last year.
“We saw valuations come down to levels that I never thought were possible in internet stocks, consumer stocks, healthcare stocks and banks,” he told FSA in an interview. “We thought they were very, very attractively priced.”
The recent rally in China’s stock market has enabled the strategy to outperform most of its peers while most emerging market managers shunned the region in favour of richly-valued India and Taiwan.
Performance of the strategy over the past 5 years
However, as the rally in China has pushed up valuations, it seems the strategy has started to pair back its overweight towards the region, according to its latest factsheet.
As of the end of February, it held a slight underweight (2%) towards China versus the MSCI Emerging Markets index. It also has relative underweights to Taiwan (6.4% underweight) and India (12% underweight).
This underweight towards India in particular has also paid off in recent months, allowing the strategy to remain largely insulated from the recent downturn in Indian equities.
As Chinese stocks look to be back in vogue amongst investors with the emergence of DeepSeek, Donald recalled how quickly the market’s sentiment towards Chinese tech giant Alibaba changed.
“This time last year, people were very unexcited about it at all,” he said. “It seemed to be a company completely without a strategy, and now people seem to really like it.”
Roughly one year ago Alibaba was trading at 8 times earnings. It has since rallied to trade at almost 20 times earnings.
A disciplined approach
The recent preference towards Chinese equities is a major change in the strategy’s portfolio allocation, but not its investment approach, which Donald said has remained the same for 25 years.
The portfolio managers start with on a bottom up, fundamental approach to selecting stocks, placing a strict emphasis on valuation and quality, with a focus on return on equity (RoE).
This RoE factor is one reason why Donald had avoided China for long periods of time: “Although China is a big market, a relatively small part of it is quality: with high and stable RoEs,” he said.
“For long periods of time, investors have wanted to have exposure in China, they’ve bid up those stocks typically to very, very high levels.”
“There’s a large part of the Chinese market that is either unprofitable or only vaguely profitable and very, very volatile. They’re not of interest to us,” he said.
Opportunities beyond China tech
Elsewhere, Donald said his strategy bought a number of Chinese consumer staple stocks he believed were at “outrageous valuations” for decades, but have since “come down to Earth”.
He recalled how tech, consumer staples and pharmaceuticals were three areas that emerging market equity investors used to label as ‘must own’ in China.
“I remember 15 years ago that people would say, ‘you have to own these long term theme stocks’,” he said.
“The narrative was people are going to get older in China, so the pharmaceutical companies are going to be huge winners. Internet: everything’s going to go through the internet, and then consumption was going to be the big game.”
These same names which have been shunned by investors for years, Donald still holds in the strategy he manages within its top 10, including the tech giant Alibaba, Chinese pharmaceutical firm Sinopharm and one of China’s big 4 banks: China Construction Bank.
