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China in a bull shop

Even after the global crisis that knocked back its market severely in late 2008, China has continued to draw in investors.

For those who invested recently, the benefits have been great, with about 30 per cent rises in the Chinese market in the past few months. What lies ahead for the market? Some fund managers are largely bullish on the region relative to other markets but there is some doubt as to whether recent rises are sustainable in the short term.

Whereas once China was considered a risky, emerging economy, these days, it would seem many are convinced that China will lead global economies and markets.

Mike Gush, fund manager of Baillie Gifford’s Greater China fund, says: “The re-emergence of China as a world economic power is perhaps going to be the single biggest investment opportunity we have seen for a generation. It is very likely that it will be the most important global economic event since the Industrial Revolution.”

Considering the damage the credit crisis has had on investor confidence, it is somewhat surprising how this high-beta market has continued to attract retail assets. According to the IMA’s May figures, the Asia ex Japan sector – where most China funds reside – was the third-best-selling sector in net retail sales. It lagged corporate and strategic bonds but outstripped the more cautious managed sectors.

Product providers continue to take advantage of the change in sentiment towards the region. More launches continue in this area, with Baillie Gifford the latest to offer a dedicated China fund. There are now around 11 such funds in the Asia ex Japan sector, including the Baillie Gifford offering which has existed since November 2008 but was made available to retail investors just last month. If launches continue in this area, a separate China fund sector may not be that far off. Typically, when there are 11 or more funds with similar remits, the IMA has put them into their own classification.

For the China bulls, there is much to rave about the region. According to the OECD’s economic report at the end of June, a recovery already appears to be taking hold in China, helped by major stimulus measures. Chinese GDP growth is forecast to be 7.7 per cent in 2009 and 9.3 per cent in 2010, an upward revision from the OECD’s March forecasts of 6.3 per cent this year and 8.5 per cent next year. Not bad considering much of the Western world, and even in other parts of Asia, is forecast to have negative GDP growth.

With a low debt ratio, much needed and anticipated infrastructure spend and a government willing to throw a lot at its domestic economy in terms of stimulus packages, China is looking attractive on many investment levels.

Still, while China’s GDP growth may remain positive, the region is not immune to the continued effects of the credit crunch. It may have positive GDP growth but its forecast levels are still quite a fall from its double-digit growth a year ago.

Premier’s enterprise China fund manager Fen Sung says he believes the medium to long-term prospects for the region are “excellent” but in the short term he is cautious. In May and June, Sung sold out of his positions in more cyclical stocks and has taken a defensive stance in his portfolio, believing that China will be negatively affected by another leg down in global stockmarkets.

Sung believes, globally, market valuations have moved too far ahead of earnings and this is likely to end in a correction. As China remains dependent on exports, it will be hurt by such a move and the likely turn in consumer and investment sentiment that such an event would spark. He says: “I don’t believe in decoupling. In fact, I believe markets are more correlated than ever.”

The MSCI China index is currently on a forward p/e valuation of about 15.5, which Sung believes is too high, considering his outlook is that global economies are not yet out of the woods. In late 2008, the market was trading on a p/e of around 7.5, almost half of its current level just eight months on. He says China is in a disinflationary market and policymakers need inflation to come back soon.

John Greenwood, chief economist at Invesco Perpetual, says inflation is falling sharply across the region. He says: “Even in China, there are signs that the economy could run into trouble quickly in response to the central government’s huge fiscal and monetary stimulus plans. Inventories of raw materials have built up to a level where prices and demand can only weaken and the extraordinary acceleration in bank lending and money growth risks a build-up of bad debt and/or inflation over the next year or two.”

Invesco Perpetual’s Hong Kong & China fund managers Paul Chan and Samantha Ho say in May, China’s central bank was sounding a note of caution, pointing out that the foundations of recovery remain fragile and they believe the global economy has yet to bottom.

Within this near-term cautious outlook and long-term bullish sentiment on the region, managers such as Sung have raised their weightings in areas such as industrials while underweighting exporters. Invesco’s Chan and Ho are overweight in energy and are also underweight in financials.

Within the Greater China area, Sung is underweight in Hong Kong banks and is light on Taiwan where there are bigger economic concerns. Despite the more defensive stance in his portfolio, Sung says he is looking to take advantage of market falls to add value to his portfolio.

Whatever occurs in the coming months, either in Western or Asian markets, the long-term story of China appears to have taken hold.


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