It would be fair to say that investors in China have not enjoyed the best fortunes over the past 12 months. According to data from FE Fundinfo, the IA China/Greater China sector was the worst-performing peer group in 2023, registering a fund average fall of 20.4%. These woes have continued into 2024, with the sector once again finishing bottom of the sector rankings in January, with the average fund return falling 9.2%.
While investing in China, or any emerging market, is a long-term game, the story over three and five years is just as stark, with the sector down 49% and 16.5%, respectively. The economic picture is just as uninspiring, as China faces the prospect of lacklustre growth in 2024, with GDP expected to grow 4.5% in real terms, compared with 5.2% in 2023 and 6+% levels in the years before the Covid pandemic. It is little surprise then, with funds under management of just £3.7bn ($4.67bn), according to the IA over the course of 2023 to November, the IA China/Greater China sector saw outflows of close to £188m.
So, as all eyes focus on China as it enters the year of the dragon, is it really all bad news? In this discussion, James Klempster, deputy head of the Liontrust multi-asset team, explains why he is becoming more optimistic towards China, while Andrew Mattock, portfolio manager at Matthews Asia, calls for patience from investors.
James Klempster, deputy head of multi-asset, Liontrust
As long-term, disciplined investors, we are focused on identifying investment opportunities rather than being distracted with macro stories. While a positive economic backdrop should provide a tailwind to markets, fundamentally poor investments are unlikely to prove rewarding, even with a metaphorical gale at their backs.
Over the past 20 years, investors in Chinese stocks have regularly conflated a positive view on the economy with a positive view of the stockmarket, but history has often shown this to be a poor strategy. There are many hazards that can impact markets even against a benign, positive macro backdrop. Important factors to consider include corporate governance: whether there is a genuine culture of rewarding shareholders, and whether capital controls could hinder your ability to retrieve your investment in the future. Even if the above factors are in your favour, investing at the wrong price can mean you’re pushing a rock uphill to get returns.
Similarly, the separation of an investment case from the macro story is equally important when news flow is universally negative. While the Chinese economy is in the doldrums and experiencing an insipid recovery, it does not necessarily follow that the stockmarket should also be written off.
The draconian Covid lockdowns followed by a surprise reopening, political crackdowns on ostentatious wealth, education provision and the property sector have all led to a degree of growing caution among investors, catalysed by a flaring of geopolitical risks.
The combination of Covid, political and corporate developments have acted to rein in globalisation, with heightened geopolitical risk arising from tensions in the Middle East and the ongoing Russian-Ukrainian war further accelerating this contraction. On top of this, China faces demographic headwinds with a declining population and an ageing workforce.
Glimmer of hope?
However, not all economies are created equal, and a poor year for China will still see growth outstripping much of the developed world. The Chinese government continues to focus on improving GDP per capita and moving its economy steadily towards higher-margin, value-adding industries such as electric cars and other technologies.
The latter can, of course, cause alarm, stoking concerns surrounding national security, with governments such as the US having a sceptical view of Chinese technology giants. And while the frosty Sino-US relationship has thawed slightly of late, the US government clearly wants to reduce its reliance on Chinese inputs into its supply chains.
Emerging markets’ poor performance over the past two to three years has a lot to do with problems stemming from China. But now China has adopted a more pro-growth, stimulus-oriented stance, emerging markets could benefit from the relative appreciation of their currencies versus a weakening dollar. They will be further boosted by international strategic supply chains being re-opened.
We do not have direct exposure to Chinese equities through a dedicated fund: an important consideration in our portfolio construction is the avoidance of an over-concentration to any countryspecific risk. Instead, we prefer to access the market in our global diversified portfolios through allocations to Asia ex Japan and emerging markets funds.
Indeed, through our overweight positions in these regions, we are currently overweight in China. Undoubtedly, there are some interesting China managers, but for us to back these strategies, we would like to see a greater number of Asia ex China and emerging markets ex China funds to avoid doubling up on our Chinese allocation.
Overall, we believe valuations on Chinese stocks remain attractive and this will prove rewarding for investors against a more forgiving economic backdrop, as indeed it will for other emerging markets and Asia ex Japan. The main driver of returns will come from the re-rating of stocks from their lowly valuations, which should follow any shift in sentiment from the current levels of scepticism that is keeping a lid on pricing.
Andrew Mattock, portfolio manager, Matthews Asia
Last year was a disappointing one for Chinese equities and the Chinese economy overall. It’s disappointing, in our view, not just in the sense of the underwhelming recovery of Chinese consumer spending post-Covid lockdowns, but also due to the lack of any significant stimulus measures by the government.
Although the government did start to gradually loosen property purchase restrictions across most cities in China, the expectations of potential home buyers regarding future house prices and their own income levels have changed. As a result, these policy changes barely helped to arrest the slump in the real estate market. As the year progressed, investors gradually gave up on the idea that the Chinese central government would step in to engineer a stronger consumption rebound.
From what we can see, many entrepreneurs – whose animal spirits were curbed during the Covid period – are now hesitating to start any new investments in this environment. From a geopolitical standpoint, the highly anticipated Biden-Xi summit in San Francisco in November didn’t really impact the ongoing concerns of the market. And staying at the macro level, Chinese equites were a key exception in a November global equities rally that followed signals by US Federal Reserve chair Jay Powell that the US interest rate-upcycle was near an end.
Both domestic and international investors have had their confidence severely tested over the past three years. There is no ‘natural’ inflow into China’s market through pensions or retirement savings plans and that has left only selected groups of companies with strong cashflow and balance sheets being active in the market, buying back their own shares.
Although we don’t fully subscribe to the theory of a ‘Japanification’ of China, we believe the government needs to do a lot more to avoid this trap and the risk of a ‘lost decade’.
Looking ahead, we remain cautiously optimistic that there will not be further meaningful deterioration in the property market. While we do not expect significant warming of geo-relations, the current status quo of a more constructive post Apec posturing would be welcomed by the market. Patience is a virtue
Among the traditional drivers of Chinese economic growth, aside from real estate, the export sector is still demonstrating some strength. However, as China grows its share of global industrial output, it raises the spectre of more trade frictions alongside continuing US tariffs.
In terms of consumption, the third economic driver, Chinese consumers are likely to continue to behave very conservatively due to a lacklustre employment market and bleak outlook for income growth. Industries with high-paying jobs have unfortunately become casualties of tightened regulation and some have been subject to pay-cut directives from the government.
Valuations continued to trend down in 2023, and the broader China market hovers around similar levels as 2009, despite a better-quality businesses and earnings profile.
We continue to believe that patience is needed in these market environments and that it will ultimately pay off once the market turns. In the current environment, we continue to stick to our knitting and deliver a consistent growth at a reasonable price strategy for our clients.
This article was written for our sister title Portfolio Adviser’s February magazine.
