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Darius McDermott: Tapping into the biggest risk/reward market of 2023

No-one is suggesting China is anything but volatile but things are starting to get interesting.

If you had asked me two months back if I planned to invest in China, I would have immediately said no because there is simply too much uncertainty on the downside about the world’s second largest economy.

Yet it feels like the past few weeks have seen things come to a head in China. We have seen the patience of the population finally snap over a tough zero-Covid policy – resulting in large demonstrations and an unprecedented challenge to President Xi Jinping across some of the biggest cities in China – quickly followed by the Chinese government relenting on some of its policies, such as forcing people with Covid into strict quarantine camps.

To be clear, I am not saying China is anything but volatile but things are starting to get interesting – not least from a valuation perspective, given markets are down more than 40% since government intervention in both the technology and education sectors in February 2021.

There is sometimes a point where valuations are simply too good to ignore – and it would be surprising if they don’t look attractive 10 years from now. You could even argue they will be value over the medium term.

Yet valuations are just one point of the China discussion – as there have been a few catalysts garnering some interest in the economy. A good example is the recent 20th Party Congress, where not only were plans made to boost’s growth, but initial measures were already put in place to tackle Covid and prompt an economic recovery, such as promoting vaccines amongst the elderly. Moves were also made to tackle the troubled property sector.

Continued focus on financial easing

We must also remember that, in a world where inflation is running wild, China is the only major economy continuing to focus on financial easing, while much of the world is tightening interest rates. Another factor is that China’s recent growth story has been intertwined with consumer technology – but the sector is also focusing on high-tech manufacturing and embarking on a new wave of innovation intended to secure its position as the global leader in industrial tech – all of which will play an integral role in self-sufficiency.

I recently read that China’s most recent five-year plan, published in 2020, featured the word “innovation” 165 times while “digital” appeared 81 times. Effectively, tech is at the hub of the government’s plans to double growth by 2035. The growth in electric, semiconductor demand and even robots to help tackle the challenges of an aging population are all credible examples. There has also been significant growth in the industrial and healthcare technology sectors, further highlighting the need for innovation.

Although poor demographics are a challenge for China, we must also remember the region has a number of tailwinds. China’s masterplan is clear – it is building new cities based around integrated travel systems, 5G networks and cross-country travel. The current high-speed rail network is 23,500 miles of lines crisscrossing the country, China had no high-speed railways at the beginning of the 21st Century – just think about that for a second.

This all shows the future of China is being planned many years in advance, whereas other leading economies are merely trying to patch up their existing systems. This should allow China’s domestic market to take off in the next few years, with the rising ‘middle class’ looking to increase their quality of life with better healthcare, transport, housing and discretionary goods. It is moving to a consumption-led economy – and, when that happens households will start to leverage.

Clearly regulatory and geopolitical concerns remain significant threats and we are by no means saying it is only onwards and upwards from here – far from it in fact. But valuations, coupled with a number of other recent and long-term changes are starting to make the region investable once again, for those willing to take the rough with the smooth. So here are a few ways to approach the region:

The traditional play

For core exposure, I would look to an experienced manager backed by a strong team in the region. A good example would be Invesco China Equity, managed by Mike Shiao. Based in Hong Kong, he is supported by a team of 20 analysts across the region to help identify the best companies from across the three markets: the domestic Chinese A Share market, the Hong Kong listed H Shares and the American listed ADRs (American Depositary Receipts).

Shiao aims to identify companies with a competitive advantage over their peers, and sustainable leadership in their industry, and specifically targets companies he feels are undervalued by about 25% to 30% and holds them with the expectation they will reach fair value over a three to five-year time horizon.


There is also the rapid growth in A-Shares to consider: there are more than 3,000 listed companies onshore in China, many of which are very liquid. This depth allows managers to pick and choose interesting bottom-up stock ideas – although there are risks attached.

At a time when asset correlation is being significantly questioned amid market falls, A-Shares offer true diversification to global equities. In fact, according to Allianz Global Investors, China A-shares have only 0.32 correlation with global equities in the last 10 years (on a scale where 1 is fully correlated and 0 is completely uncorrelated). This means A-shares move in a different direction to global equities almost 70% of the time – by way of comparison, US equites have a 0.97% correlation.

Those looking for access to the A-Share market may want to consider Allianz China A-Shares, managed by Anthony Wong and Kevin You.  The fund aims to return 3% to 5% a year on top of the index, over a market cycle and gross of fees, by investing in some 50 to 70, predominantly large, Chinese companies.

ITs’ benefits

Investment trusts clearly have a number of benefits thanks to their closed-ended structure. In this case not only are we able to access a region at an attractive valuation point, but also through an attractive discount rate. A good example is Fidelity China Special Situations, which is currently operating at a 7.6% discount, according to TrustNet. Managed by Dale Nicholls, the trust invests predominantly in companies listed both domestically in China and on the Hong Kong Stock Exchange. The trust has a bias towards mid and small-sized companies.

Diverse approach

Those wanting a wider Asia portfolio with some exposure to China, meanwhile, might consider Fidelity Asia Pacific Opportunities, which currently invests more than 30% of its portfolio in China. Manager Anthony Srom adopts a high-conviction approach to investing with this Asian equity fund, building a portfolio of just 25 to 35 names.

This story first appeared on our sister publication, Portfolio Adviser.

Part of the Mark Allen Group.