China: is the international backlash a worry for investors?

Not so long ago, the West was ‘beating a path to China’s door’ seeking to ride on its coat-tails, as its economy underwent rapid expansion. But over the past couple of years, tensions have escalated.

Donald Trump has been confronting the country via twitter and other means since April 2018 and now other countries are following suit: the UK has backtracked on its verbal agreement to use Huawei for 5G, France has been critical, and Australia has renewed rhetoric about China’s alleged concealing of the origins of Covid-19.

China has, of course, responded – via tit-for-tat trade wars with the US, cyber-attacks in Australia and warning the UK that we are “making a very grave mistake making an enemy of China” and that there “will be consequences”.

How did relations with China go so wrong so quickly?

Alastair Irvine, co-manager of Jupiter Merlin Balanced Portfolio, says that Covid-19, with its origins in China, “has become a lightning rod for a situation which has been simmering for years,” with the pandemic – and significant disruption to the global supply chain – highlighting the West’s over-reliance on China.

But the origins of today’s antagonistic situation have been gradually fomenting for half a century, according to Alastair. “For a generation or more, cooperation suited both the West and China,” he said. “Each used the other to its own ends. A source of cheap but hard-working, high-quality labour, Chinese companies were contracted by western businesses as manufacturers of usually low-value-added components to be exported for final assembly into higher value finished products close to the point of sale.

“Chinese exports grew rapidly, dragging its economy with it: 40 years ago China accounted for 2% of global GDP (in context, the US and what would now be the eurozone were 26% each). Growing at double digit rates, by 2007 China’s share had doubled. By the end of 2018 its GDP was bigger than the aggregate of the eurozone’s 19 countries and is challenging the US, albeit America still leads with 24%. It has been a phenomenal rise*.”

“As the economy has grown and its share of global GDP has accelerated, so too China’s interests and strategic ambitions have evolved to the extent the Chairman of the FBI felt moved recently to highlight the threat to the West and the United States in particular.”

What does anti-China rhetoric mean for investors?

“Companies are re-evaluating their China ties,” said Alastair. “Whether they be commercial opportunities, supply chains or direct investment in bricks, mortar and equipment; sanctions and tariffs add another dimension.”

Andy Rothman, investment strategist at Matthews Asia, home to Matthews Pacific Tiger fund, is less concerned. “Although I am pessimistic about the near-term trajectory of the Washington-Beijing political relationship,” he said, “I remain optimistic about China’s economic prospects. Because China is a domestic-demand driven economy, there is a low risk that bilateral political tensions will derail the V-shaped economic recovery it is currently enjoying.”

Andy says that China’s economy is increasingly driven by domestic demand, and although consumer spending is likely to remain softer than usual until next year, on a relative basis China is likely to remain the world’s best consumer story.

“I expect China’s economic activity to return to about 80% of normal by the end of this year. Restaurant and bar sales were still down last month, due in large part to lingering fears many people have about gathering indoors. It is likely that this part of the economy, as well as other businesses that require customers to gather in confined spaces, will take a long time to fully recover.”

Fidelity’s Hyomi Hie, agrees that the reshoring of Chinese consumption in particular, remains strong. “With nowhere to go, previous overseas spending from Chinese consumers will be rechannelled into domestic areas,” she said. “We believe that a significant portion of this will be structural and sustained in future years after Covid-19 passes and this will likely accelerate the existing shift from goods to services consumption, as well as a growing preference for premium brands and domestic brands.”

Three funds backing Chinese companies

While you would expect funds and trusts like Fidelity China Special Situations and Invesco China Equity to back their asset class, a number of Asian and emerging market managers like Chinese companies too.

Newly Rated Aubrey Global Emerging Markets Opportunities has a huge 57.9%** invested in the country, although this is perhaps unsurprising as the fund taps into the fast growing consumer opportunity across the world’s emerging markets, investing in companies offering products and services to the upwardly mobile, ambitious and aspirational population centres which account for over 70% of the world’s growth.

T. Rowe Price Asian Opportunities Equity has 36.3%** invested in the country, although this is technically an underweight position. Manager Eric Moffett told us why he thought Europe’s relationship with China is more important than America’s in this podcast interview:

Meanwhile, Scottish Mortgage Investment Trust has a 19%^ weighting to Chinese companies, including Tencent, Alibaba and Meituan Dianping – an online shopping platform for locally found consumer products and retail services including entertainment, dining, delivery, travel and other services – which are all in its top ten holdings**.

Three funds that are underweight China

Stewart Investors Asia Pacific Leaders has just 6.8%** invested in China – considerably less than the 39.4%** index weighting. Deputy manager Chris McGoldrick, told us why he prefers Indian (31%**) and Taiwanese companies (17.7%**) in this video interview:

Newly Elite Rated Guinness Global Innovators has a 9.5%** weighting to China, preferring US companies at this time (67.4%**) when it comes to finding innovative and disruptive businesses which are changing the world in which we live. The managers have identified nine innovation themes from which they pick the highest quality, fastest growing and best value companies.

Find out more here

Jupiter Asian Income has 11.5%** invested in Chinese companies, preferring those domiciled in Hong Kong, Taiwan and Australia. The fund aims to capitalise on the opportunities of today, as well as the potential of tomorrow, and is not afraid to hold much more or less of certain countries than its benchmark in pursuit of this aim.

*Source: Bloomberg, 31 December 2018
**Source: fund factsheet, 31 July 2020
^Source: FE Analytics, 20 August 2020