ASI beats the drum for A-shares

Domestic retail buying, active overseas funds seeking non-trade related China exposure, and passive and active foreign investors responding to index inclusion all contributed to a strong performance by China A-shares last year, said Nicholas Yeo, head of China equities at Aberdeen Standard Investments (ASI) at a media briefing in Hong Kong this week.

The MSCI A Share Onshore index, which represents large- and mid-cap stocks listed in Shanghai and Shenzhen, posted a 37.48% return in 2019, outstripping the MSCI China index, comprising foreign-listed China shares, which rose 23.46%, according to FE Fundinfo data.

Yeo was eager to stress the attractive valuations of A-shares, which are below long-term historical averages, while average earnings growth – at 15%-20% – is stronger than for MSCI China, MSCI Emerging Markets and MSCI World, according to Bloomberg data.

“That, no doubt, was a factor underpinning the market last year and we anticipate will be again this year,” said Yeo.

Structural changes

However, Yeo’s case for A-shares is largely based on what he thinks are structural changes underway in China. He reckons the “winners” over the long term will be companies with strong balance sheets and governance standards that are tapped into trends such as the broadening of domestic consumption.

“The spending power of China’s fast-growing middle classes as urbanisation gathers pace will continue to drive local company revenues and profits. This will translate into investment opportunities in A-shares,” he said.

Other China fund managers, such as Alexander Treves, investment specialist for emerging markets Asia Pacific equities at JP Morgan AM agree.

Last August, he told FSA that the A-share companies will grow in importance for the Chinese economy and become a larger part of market indices because they  service the “upgrading consumption preferences” of China’s expanding middle class.

Treves highlighted healthcare, technology, leisure and entertainment, tourism, food and beverages and household goods sectors, which are “well-represented in the A-share market”.

Yeo pointed out that the Chinese government is also promoting domestic consumption as the driver of the country’s economy, and that millennials are heeding its call to spend their cash.

“As a result, we see further growth in the high-end food and liquor, travel, healthcare and life insurance sectors,” he said.

Exposure to shifting habits

Yeo manages the $3.56bn Aberdeen Standard Sicav I China A Share Equity Fund, which has been awarded a maximum five stars by Morningstar and the equivalent rating of five crowns by FE Fundinfo.

Leading Chinese distillers Kweichow Motai and Wuliangye Yibin are among the fund’s top 10 holdings because of Yeo’s expectations that higher wages might be spent on better quality booze, and he also highlighted operators of airport and duty-free shopping as a long-term play on the growth of aviation and tourism in China.

“Some of these businesses are virtually monopolies, reinforcing their earnings quality,” he said.

In the healthcare sector, the fund’s exposure includes a leading hospital, a contract research provider for the pharmaceutical industry and traditional Chinese medicine manufacturers.

The top holding is Ping An Insurance because “life insurance is under-penetrated, which bodes well for future growth in premiums”.

The fund has generated a 78.56% cumulative return during the past three years, according to FE Fundinfo, which was way in excess of its benchmark MSCI China A Onshore index (10.30%), which suffered its worst performance of a decade in 2018 and failed to reflect the strong positive returns of the overseas-listed shares that make up the MSCI China index in the previous year.

The fund has also comfortably outperformed the average return of the sector, comprising 107 funds authorised for sale in Hong Kong and/or Singapore, which include products with exposure to China H-shares and ADRs, as well as A-shares.

The fund has annualised volatility of 19.32% over the past three years, higher than the sector average (17.44%), but a little lower than the benchmark (19.68%).

Top 10 holdings

Source: FE Fundinfo (30 November 2019)

Mitigating risks

Yeo conceded that companies in mainland China “still have progress to make on financial transparency and investor protection, and that many have too short an operating history and disclosure can be poor”.

“That said, governance in China is improving steadily, which has gone hand-in-hand with our increasing comfort with investing in this market,” he said.

Yeo stressed that the best way to hedge against the risk is to scrutinise companies thoroughly and only invest in quality.

“We define quality as a strong balance sheet and consistent, diversified earnings, good governance and an experienced management team with a strong track record,” he said.

The inclusion of A-shares into global benchmark indices will also help to institutionalise the onshore domestic market, improving governance standards and encouraging foreign investment into Chinese stocks, he added.

Meanwhile, the opening up of Stock Connect links between Hong Kong, Shanghai and Shenzhen since 2014 and elimination of quotas for the QFII and RQFII schemes has facilitated easier access and increased participation.

However, other leading fund managers, such as HSBC GAM and T Rowe Price, have warned about the volatility of the A-share market, which despite index inclusion and easier access to foreign institutional investors, is still predominantly retail-driven.

Yet, Yeo also sees A-shares as a defensive play – if only by implication.

Although he is heartened by the US-China phase one trade deal, recent monetary stimulus by the Peoples’ Bank of China (PBOC) and indicators pointing to the stabilisation of Chinese economic growth, he expects another year of market fluctuations.

“Volatility will likely remain in play given potential economic and political obstacles to a more comprehensive US-China trade deal, and also uncertainty in the build-up to the US presidential election,” he said.

Against this background, Yeo believes that domestically-focused Chinese companies are better insulated from a possible deterioration in trade relations or global growth.

Aberdeen Standard Sicav I China A Share Equity Fund vs sector average and MSCI China A Onshore index

Source: FE Fundinfo. Three-year cumulative returns in US dollars.