China: an investment opportunity or one to avoid?

China has seen unprecedented daily outflows of capital in recent weeks, according to data from the Institution of International Finance.

Investors started falling out of love with the country last year, following a regulatory crackdown by the Chinese Government that adversely affected companies in sectors such as technology and property. This change of heart has only increased since Russia invaded Ukraine and investors have sought safer havens.

But what is the outlook for this Asian powerhouse? With the Chinese stock market now
below where it was at the start of the pandemic*, is it a possible opportunity or the end of China as a viable investment for foreign investors?

In this analysis we look at what fund managers believe is in store for China.

China’s booming popularity

The amounts invested in the IA China and Greater China sector had soared from £2.4bn at the start of 2020 to £4.9bn by June last year, according to Investment Association data. Enthusiasm for China was fuelled by the way it responded well to the Covid-19 pandemic and led the global economic recovery.

It’s GDP grew by 2.3% during 2020, according to the World Bank. This may seem modest, but it came at a time when most other countries were in negative territory. The data showed the United States was down -3.4%, while the UK was badly hit, with the economy shrinking by -9.4% over the same period.

Fund performance

Funds investing in China enjoyed a bumper year as a result. It meant that investors who piled into the story were richly rewarded. In fact, the average return achieved by funds in the IA China and Greater China sector was an impressive 33.6% during 2020**. By way of contrast, the IA North America sector returned 16.2% and the popular IA UK All Companies sector lost 6%**.

However, the following year proved disastrous. The average fund China equity fund lost 10.7% during 2021***, while the average US equity fund was up 25.5% and the average UK equity fund rebounded 17.3%***.

Unsurprisingly, investors have headed for the exits. In fact, the latest data for January 2022 reveals UK investors now have just £3.9bn in the sector*.

But are they missing a trick? China may be wrestling with regulatory issues but it’s still home to many global giants. Does this make it worthy of attention?

The outlook for China

China is the second largest asset management market in the world by assets under management and expected to overtake the United States within the next few years, according to Invesco. Its report, China position 2021: Sustaining institutional interest, said the Chinese Government’s commitment to opening its markets has helped support the transformation of its economy.

The study was based on surveying 200 asset owners from across the globe to understand how their investment stance towards China is evolving. It concluded: “China’s growing economic strength, its shift from export-oriented to a domestic-demand driven economic model, the growing number of international companies, increasing consistency in meeting global standards, and its rapidly developing financial markets, all combine to make the country an attractive investment opportunity, according to our asset-owner respondents.”

According to Janus Henderson, China is also now the world’s largest exporter and the second largest importer of merchandise goods. Not only that, but private consumption in China is expected to double and reach $13 trillion by 2030 – accounting for one-quarter of all global consumption growth. And with almost 7,000 Chinese listed companies in which to invest, there is an immense choice for investors.

Views of Asia fund managers

Abbas Barkhordar, deputy fund manager on the Schroder Asian Alpha Plus fund, says that after a torrid year in 2021, some investors had hoped for calmer seas in 2022 “Unfortunately, that has so far proved to be rather optimistic, with the MSCI China index remaining extremely volatile and already down a further 12.5% in sterling terms since the start of 2022,” he said.

“There have been a number of negative developments driving this latest bout of market weakness in China; each individually concerning but in aggregate leading some investors to question whether the market has now become uninvestable,” he continued. “We don’t believe that – there are still plenty of excellent companies to invest in in China, across A- shares, H-shares and overseas, with strong management and resilient business models.”

Charlie Dutton, manager of the Ninety One Asia Pacific Franchise fund, believes investors in China’s technology sectors and other areas should be feeling more confident. “Regulatory crackdowns on technology, education and other industries have tested the nerves of even the staunchest investors in the past 12 months,” he said. “But as the dust settles, it is becoming possible to assess the economic impacts of the new rules.”

He pointed out that the long-term drivers of structural growth come back into focus as the near-term regulatory noise starts to fade away. “The overall poor sentiment towards Chinese equities in 2021 sparked a general de-risking by global investors towards China,” he added. “This has created opportunities within some stocks for confident tigers to pounce on.”

China is still the largest absolute country position^ in the T. Rowe Price Asian Opportunities Equity fund, which is managed by Eric Moffett. In February, the fund invested in Chinese companies with meaningful exposures to quality internet, e-commerce, insurance, electrical equipment manufacturing, and consumer-related names.

“We took advantage of share price weakness to acquire quality names, which we believe are likely to revert to their long-term levels,” said Eric. “We also have exposure to cyclical stocks with good medium-term growth prospects.” Within property, Eric also bought select state-owned companies that are viewed as market share gainers and steady earnings compounders, even amid the current property downturn.

Russia’s invasion of Ukraine has raised the question of whether China will see this as an opportunity to take over Taiwan, according to Edmund Harriss and Mark Hammonds, co-managers of the Guinness Asian Equity Income fund.

“Only a few months ago, the idea of an invasion in Ukraine would have been dismissed as almost inconceivable and therefore we cannot rule out a similar move by China,” they wrote in an update.

However, they don’t believe reunification with Taiwan is a priority. “China’s goal over the last forty years has been to restore the country’s economic strength and to maintain domestic stability through a steady improvement in the standard of living,” they said. This process has increased China’s engagement with the world’s trade and financial system.

“China’s foreign exchange reserves are over $3 trillion while the value of merchandise trade last year exceeded $6 trillion,” they added. “Its economy is estimated to reached $18 trillion in nominal terms in 2021.”

The managers also pointed out that China had been trying to develop key industries that rely less on labour and more on value-add, in which it can enjoy a competitive advantage. “As part of this programme there have been efforts to open up to foreign investors, develop more localised centres of production to secure supply chains and create better international access to the capital markets through the Stock and Bond Connect schemes,” they added.

*Source: FE fundinfo, MSCI China, total returns in sterling, 28 March 2022
**Source: FE fundinfo, total returns in sterling, calendar year 2020
***Source: FE fundinfo, total returns in sterling, calendar year 2021 for the IA China/Greater
China sector, IA North America sector and IA UK All Companies sector.
^Source: T. Rowe Price, 28 February 2022