From an equity perspective, valuations in the A-shares market have remained relatively stable despite the recent quick rise of the markets. If we compare the valuation with the US market, it still appears very attractive, especially in the context that China will be the only country with positive GDP growth for 2020 - meaning that corporate earnings scores will still remain positive going forward.
Looking at the relationship between the China equity markets with GDP, the size of the equity market is still not matching the size of the overall national economy in the same way that the developed economies of the US and Japan do. We believe that there are many opportunities in the equity market that can deliver good return.
Over the last five years, for foreign investors who have participated in A-shares markets, many have been able to generate huge alpha. At the end of 2019, personal trading accounted for more than 50% of the free float, which shows that, especially in China-A shares, fundamentals-driven institutional investment strategy can outperform the market.
Although there is significantly more research of the equity market than there was 10 years ago, it (the market) is comparatively under researched. Therefore there are challenges created, but it does provide opportunities across the depth and width of the market to pick out long term winners.
When should we expect full inclusion in major indices?
Liquidity for foreign investors has improved enormously over time. If we take from 2006, foreign holders have gone from near 0% to 8.5%, showing that foreign investors are already flowing into Asian markets at a rapid pace.
We recognize, though, that there are some regulatory hurdles that must be faced here. For example, at the moment the Chinese government has a 20% cap on free float for foreign held shares.
If we look at the Korean market, it took six years from zero to 100% inclusion in indices, so if MSCI follows this precedent for China, we are still four years away from full inclusion.
Should you consider changing your allocation to China in the coming 12 to 24 months?
Looking at the shorter term we see seasonal GDP rebounds, as shown by the 3.2% growth in Q2, boosted by the national infrastructure spending.
With the global pandemic still not fully controlled, there is a risk of external demand remaining weak, so the Chinese government has utilised a lot of policy tools to boost economic growth. In the longer term, we have identified three key contributors to economic growth for the Chinese economy - consumption, demographic changes and technological advancements. Indeed, increased consumption in the future will be driving economic growth rather than investment.
In terms of currency, given the Chinese Central Bank has a relatively disciplined monetary policy, we don’t see a downside or currency risk for RMB if the valuation remains steady. We are very bullish on longer term growth prospects of the market, given the global low interest rates and steady currency rates.