Investors in the Chinese space have experienced two years of whiplash. While the MSCI China Index notched up an impressive total return of 25.7% in 2020, in 2021 it slumped 20.9 percent. Worse still, since the Year of the Ox began on 12 February 2021 it tanked 34.5 percent. Chinese ‘growth’ stocks have had a particularly brutal run, with increased state interference in big tech companies; the MSCI China Growth Index is down 43.3 percent since the same date.
Holders of emerging markets funds will have witnessed the impact given China is the largest country component of the index, although active managers have taken steps to reduce their exposure to Chinese equities, with many changing their focus to India. China represents 31.4 percent of the benchmark MSCI EM index (as at 31 December 2021) - down from a peak level of 43 percent the year before.
However, this nation of 1.4 billion peoples has upset expectations in the markets countless times since its admission to the WTO in 2001. As 1 February marked the new Year of the Tiger, change may be on the horizon.
Edouard Carmignac (pictured), chairman and chief investment officer at Carmignac, still sees potential: “China has been very good to us in years before and it's bound in my view to be one of the best markets in 2022.
“China is evolving ahead of us [in the West] by having a more accommodative monetary policy, and a more active fiscal support of growth, provided that the Omicron variant [of Covid-19] does not freeze its activity. There should be sustainable growth and at the same time, lesser rates, so we are quite keen on China.”
Paul Jackson, global head of asset allocation research at Invesco, also identifies that China’s central bank will be loosening in 2022 while other national banks will be tightening. The nation’s wider regulatory outlook has been a cause for concern however, with a legislative attempt to temper a property bubble contributing to a liquidity crisis facing the Evergrande Group, China’s second largest property developer, since 2021.
Like Carmignac, Mr Jackson also sees a guarded potential for China from an investment perspective: “Looking at the situation on a cyclically adjusted P/E ratio, China is clearly much lower than every other region and when you compare it to the US, China's CAPE ratio is below its historical norm whereas in the US it is way above. So, there is a valuation argument that is intriguing,
“Investors have got to weigh up the regulatory risks, and I think what regulation has done is basically increase the risk premium that is applied to Chinese stocks. So investors need to see them go even cheaper than they would have done historically.”
There is also the issue of corporate governance, with many investors of the belief that publicly run Chinese companies are more beholden to the Chinese Communist Party than shareholders, and long standing human rights concerns in the nation ranging from forced labour in the supply chain to the stripping of civil liberties in Hong Kong.
Jason Hollands, managing director at investing platform Bestinvest, part of Tilney Smith and Williamson, observes China as an investment opportunity while keeping these ESG troubles in mind: “Fraught international relations, however, remain a concern for investors in China with the national security crackdown in Hong Kong and treatment of ethnic groups in western China.”
“Ethical considerations aside, this friction with western democracies has been largely insignificant in the investment case compared to Beijing’s own domestic policies. Here, there is some evidence that the policy pivots of early last year to tighten regulation, crack down on certain sectors and improve wealth distribution are ‘enough for now’ as Beijing refocuses on growth.”
Mr Hollands points out that the average Global Emerging Markets fund is underweight with 28.1% exposure, according to data provider Morningstar. Bestinvest’s further top picks also include Aubrey Global Emerging Markets Opportunities, which focuses on the theme of growing consumption and services in emerging markets, and has 35.4% in Chinese stocks.
Another geopolitical twist in the tale that investors might want to keep an eye on is that while international focus is currently on a possible Russian invasion of Ukraine, China has the simmering potential to use military means to stake its claim on Taiwan, perhaps even going as far as launching a full scale invasion of the island nation.
Of this possibility, Gergely Majoros, member of the investment committee at Carmignac, says: “Political and military events are unpredictable for investors. A potential Chinese invasion of Taiwan would certainly have global repercussions in number of areas, among others, for the semiconductor industry.
“Today, Taiwan has a significant competitive advantage in this industry, especially in the manufacturing of the most advanced chips. At the same time, several countries have decided to reduce their dependency on Taiwan in this area. Well-known international competitors, mainly out of the US and Korea, have started to invest heavily in this area, in order to catch up over the coming years.”
