Why has China clamped down on its education sector?

Sam Slator 05/08/21 in Strategy

Having celebrated its centenary on 1 July, China’s ruling political party reminded us just three weeks later that it is indeed communist in nature. To the surprise of markets, it unveiled a sweeping overhaul of the afterschool tutoring industry, banning companies from making profits, raising capital overseas or going public.

These regulatory changes came on the back of other crackdowns made over the past 6-9 months on technology companies, property sectors and bitcoin. Investors got spooked. The Chinese stock market fell more than 14%* and wider-Asia was down 4%*.

As Julian Chillingworth, chief investment officer at Rathbones put it: “Over the past 40 years the government has done an incredible job of assimilating policies, institutions and tools that would make Chairman Mao howl with sadness. But every now and then it does something that is so far from the Western-capitalist playbook that it makes investors’ heads spin.”

We gathered the views of a number of professional investors from companies with Elite Rated funds in the country to understand their thoughts on the clampdown and what it means for our investments in China.

Paras Anand, Asia Pacific chief investment officer at Fidelity

“For some investors, the actions against the tutoring sector raised fears of a worst-case scenario involving a suffocating regulatory clampdown across a broad swath of industries in China. But we think some of these concerns are being overstated.

“Regulatory intervention in China is nothing new. What is different this time is how specifically the economics of one particular sector were targeted – that of private after-school tutoring for primary and middle school students in core curriculum subjects. The measures came as a surprise but the issues they seek to address are a well-telegraphed national concern in China: how to reduce the financial burdens of parenting to help boost the country’s declining birth rate.

“Education has become widely known in China as one of the “three big mountains” (alongside housing and healthcare) whose spiralling costs in recent years have been a burden for new parents.

“For long-term investors, the indiscriminate sell-off has created good opportunities to look for bargains, especially among companies whose growth trajectories remain intact. We believe the overarching aim of recent regulation is to foster sustainable growth and boost social equality. Despite policy headwinds in some sectors, China is still on track for decent GDP growth over the next decade, while its middle class should continue to grow and see its purchasing power increase as income gaps are narrowed.”

Andy Rothman, investment strategist at Matthew Asia

“People in China are having the same debates and discussions as we are. They have concerns over competition, consumer rights, protecting small businesses, data protection, security and inequality of opportunity. But one of the big differences in China is that, as a one-party ruler, it can act more quickly.

“One of the reasons the Chinese communist party has ruled China for as long as it has is that it has been pragmatic and increasingly market-orientated. And there are no signs it wants to wind this back. In the education space, the clampdown has come on the back of a real concern about family budgets and inequality of access to education.

“Regulatory uncertainty has been a fact of life of investing in emerging markets and China for a long time and is likely to continue to be so. The Chinese economy is evolving at a fast space and the regulator is struggling to keep up. So, while it may feel like the Chinese government doesn’t want foreign investors, I don’t believe that is the case. At the same time all this has been happening Chinese regulators have been taking a series of steps to further open markets to foreign investors.

Howard Wang, head of the Greater China team, emerging markets and Asia Pacific equities at JP Morgan

“It’s not the first time we’ve seen China become ‘uninvestible’ – it seems to happen every three years or so. We had the US/China trade wars starting in 2018 and the leveraged implosion of A-share market in 2015, for example. We’ve been here before. The regulators this time seem to be a little taken aback though, as I think they felt they’d talked about their ‘first principles’ with the market already and that this move was very sector specific. The collateral damage across the wider market wasn’t anticipated.

“In this case, the afterschool tutoring market had a number of characteristics that presented a stability challenge. At primary level it had turned into a consumer staple service – everyone had to do it. But it was a large expense for families and the government felt it needed to relieve the burden, especially if it wants to encourage families to have more children.

“It’s fair to assume the government will continue to regulate industries, but in a way that is familiar to people in the West – with privacy laws, protection of gig workers, cyber security etc. And there is some element of ‘China’s communist party is doing this’ rather than ‘we’ve done it too’. China is not exiting capitalism. It is still promoting electric vehicles, renewable energy, semi-conductors etc. And it has done so much to make its market investible – seeking more inclusion in the MSCI indices, foreign ownership, etc. It’s not trying to undo that.

“From a portfolio standpoint it remains prudent to run a diversified portfolio and to identify and re-size areas of obvious sensitivity. Domestic company listings are decidedly less vulnerable, and investors can take advantage of the sell-offs to buy on the dip.”

FundCalibre has four Elite Rated Chinese Equity funds. You can find out more about each fund on the links below.

FSSA Greater China Growth
Invesco China Equity
Fidelity China Special Situations
JPM China Growth & Income

*Source: FE fundinfo, total returns in sterling for the MSCI China and MSCI AC Asia ex Japan indexes, 22-27 July 2021

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.