Five reasons to invest in China

Events in China are never a total surprise, but those seen in the last few weeks of 2022 really were eyebrow raising to say the least.

In truth it’s hard to tell which event was the bigger story: the patience of the population finally snapping over a tough zero-Covid policy – resulting in large demonstrations and an unprecedented challenge to President Xi Jinping across some the biggest cities in China – or the fact that the Chinese government appeared to relent and lift its most severe policies, such as forcing people with Covid into strict quarantine camps.

The events feel like something of a crescendo to all that has happened in the region in the past two years. Because while zero-Covid has subsequently stolen the headlines, the fall from grace was initially driven by regulatory crackdowns in 2021 of the technology and education sectors. Further concerns include the deliberate clampdown on property development – resulting in a severe liquidity crunch – and geopolitical tensions, notably with the US.

We’re also in the midst of a slowdown in growth in China – something which is not helped by the ageing population. The economy grew by 6.7 per cent a year in the past decade but is now expected to be closer to 3 per cent per annum at the end of the next one*.

The simple fact is if you invested in China in the past couple of years, your investment would be down some 41 per cent (it was down over 50 per cent until recently)**, but sometimes there are catalysts which offer hope – and a few are starting to appear.

Here are five reasons to dip your toe into the world’s second largest economy.

1. Valuations

This is perhaps the simplest, but yet the most important metric to consider. As mentioned, Chinese equities are, at the time of writing, down over 40 per cent 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. I’d stress that more volatility and uncertainty are the only certainties in China, but for a long- term investor I’d argue these valuations will look attractive 10 years from now.

As Fidelity China Special Situations manager Dale Nicholls points out: “We believe valuations are also now very attractive versus both history and other markets. In this environment, my investment process has remained consistent, and if anything, I am finding a plethora of buying ideas and opportunities and this is reflected in rising net gearing levels (the ability to borrow more for the trust).***”

2. Attempts were in place already to tackle zero-Covid and property.

Despite recent events, it should be noted that moves were already in place to tackle some of the significant challenges facing the Chinese economy.

We recently saw China’s 20th Party Congress take place. The outtakes were that economic growth remains China’s top priority, with the hope of growing China to an income level on par with medium-sized developed countries by 2035. It also took aim at the aforementioned triumvirate of challenges facing the economy – zero-Covid, the battered property sector and geopolitics.

When it comes to Covid, 20 measures have been put in place to bring some sense of normality to China and prompt an economic recovery. These include stopping the tracking of people with minor exposure to Covid cases; reducing those going into quarantine; easing of rules for high-risk cities and towns; and promotion of vaccination amongst the elderly. Attempts are also being made to make it easier to visit from abroad.

But, as the past few days have indicated, things may get worse before they get better. The country developed its own vaccines which are simply not as good as the Pfizer or Moderna offerings, and new variants have been spreading faster. China will do anything to see a repeat of the early days of the pandemic and the winter months indicate more vigilance is on the way.

3. Geopolitical events

The economic links between the US and China are huge. The latest figures indicate that bilateral trade between the two countries is worth in excess of US$750 billion annually****. Yet, since the 2018 trade war there has been much talk of trade “decoupling” between the two countries. The US and China have been implementing policies to reduce their interdependence while also protecting their domestic economies at increasing speed. That is without discussing the challenges over Taiwan – a region governed independently from China since 1949, but Beijing continues to view the island as part of its own territory.

Self-sufficiency and import substitution will continue to be major themes for China in the coming years. Recent US regulations limiting the sale of advanced semiconductor chips/chipmaking equipment used in Artificial Intelligence and supercomputing to Chinese companies have made headlines globally.

But there are two positives to note – firstly tension with the US could accelerate the development of domestic industries and supply chains in China, a trend which is clearly supported by the Government.

Secondly, there is also hope that a recent meeting between President Xi and US President Joe Biden can quell the worsening geopolitical tensions between the two superpowers. Although tensions are likely to remain high – particularly over Taiwan – it is hoped that the positivity from this meeting will not see tensions escalate further.

4. A different cycle and pent-up demand

In a world where inflation is running wild, China is the only major economy continuing to focus on financial easing whilst the rest of the world is tightening (raising rates).

Like other parts of the world, Chinese households have been saving since the start of the pandemic, with family bank balances up 42 per cent since the start of 2020 – the money is there to fuel a consumer rebound and jump start the recovery^.

5. Winds of change benefit China’s advanced tech companies

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 ageing population are all credible examples. There has also been significant growth in the industrial and healthcare technology sectors – highlighting the need for innovation.

Funds to choose from:

Funds worth considering include the FSSA All China fund and the Allianz China A-Shares fund, both of which are run by teams with excellent long-term track records.

Investors may also want to consider JPMorgan China Growth & Income trust – a high conviction portfolio of 60-80 stocks with a focus on higher quality companies.

While those wanting a wider Asia portfolio with some exposure to China might consider the Ninety One Asia Pacific Franchise fund, which currently invests 35 per cent in China^^^.

Research all Elite Rated Chinese equity funds here.

*Source: Morgan Stanley Podcast – November 2022
**Source: FE fundinfo, total returns in sterling, 16 February 2021 to 8 December 2022
***Source: Fidelity – China offers a world of opportunities
****Source: Invesco – US-China trade “decoupling” and the road ahead
^Source: Matthews Asia Sinology – November 2022
^^Source: Allianz -Winds of change favour China’s advanced tech companies
^^^Source: fund factsheet – October 2022

_{Photo by Nuno Alberto on Unsplash}