China's education clampdown represents shift in treatment of investors suggests Somerset Capital fund manager

Nicholas Earl, 10/08/2021

China’s clampdown on its private education sector represents a "small shift" in its treatment of shareholders, and could potentially increase risk across its investment universe, argues Mark Williams, co-manager of the Somerset Asia Income and Somerset Emerging Markets Dividend Growth funds.

Mr Williams believes China continues to present investors with compelling opportunities, and that its recent implementation of antitrust legislation and cybersecurity measures within the technology sector, and its curbs on shadow banking were to be expected and reflected global problems Western economies were also facing.

However, he felt that the announced reforms to the private tutoring sector, valued at around $260 billion, including banning for-profit tutoring in core school subjects, restricting foreign investment via acquisitions, and turning companies such as Hong Kong-listed Scholar Education Group and the New Oriental Education & Technology Group into not-for-profit entities, was less proportionate and unnecessarily damaging to shareholders. 

This has been reflected by plummeting share prices in the private education sector and huge sell-offs from investors.

He told Fundeye that he did not like the new measures. In his view, it represented a more negative impact on shareholders than previous clampdowns on economic sectors. 

Mr Williams said: “It seems to have been a blunter tool, when looked at from the view of minority shareholders, and potentially with international shareholders. That limits the potential and increases risk in a larger part of the overall investment universe.”

The fund manager did not suggest it represented a sea-change in the government’s approach to its economy, nor did it derail its overall positive outlook towards China and its multiple liquid, listed companies. Instead it was a small shift, rather than a significant one, and reiterated a need be mindful of both potential opportunities and pitfalls while investing in the world’s second largest economy.

He added: “I think it is a broader attack. As collateral damage, I think it is greater for some investors in a way that it hasn't been before, but there is still plenty of opportunity within China.”

In particular, Mr Williams believed that the clampdown on the education sector reiterated key differences between China’s economy and developed markets in Europe and North America.

Fundamentally, China’s economy has been tailored on the ambitions of its government, the CCP. It is a party with one real remit, which is to strengthen single party rule.

He explained: “A lot of the elements that are connected to that go in line with what you would want as a shareholder.They don't want particularly high inflation because it makes cost of living unaffordable, and they definitely don't want significant unemployment because it leads to increasing social unrest. So, those factors can actually be fairly well aligned.”

Mr Williams also noted that sometimes its ambitions went against the shareholders. For instance, state owned enterprises exist not to provide the greatest possible returns for shareholders. They continue to have a much broader remit and are responsible for job creation, while banks are expected to lend to preserve the overall economy and counteract unemployment more than increase their own profits. In the case of private education, the government intervened as they saw the burgeoning sector as damaging to the overall health of its economy, and felt it would drive inequality in it population. It is more than prepared to suppress practices it perceives as anti-competitive that could enhance a disparity of wealth that are not in its interests.

This ideological difference was outlined previously by Chartwell Capital’s founder, Ronald Chan. He argued that investors needed to accept having their ‘toes stood on’ with these setbacks.

While Mr Williams is more concerned about the heavy-handed approach to the private education sector, he also speculates that this could be a recurrent development.

He concluded: “I do think that these things, in terms of regulation, tend to be cyclical and you're obviously on a rise at the moment. Issues will be addressed and it will probably fade to a certain degree. So, I think people's concerns will become overly elevated within the midst of all this.”

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