Sector focus: China’s overlooked bright spots are cause for optimism

Global markets had a difficult start to the year, this time led down by China. The country’s ongoing growth and currency concerns undoubtedly played a part but the poor implementation of a market circuit breaker made it much worse, prompting fears about liquidity.

But why does China matter so much? Some say it is because the global economy is still incredibly fragile and cannot take a lot of shocks. Whether or not that is true, China has contributed almost a third of global economic growth in the past couple of years, according to the International Monetary Fund.

A colleague of mine wrote recently: “Yes, there are issues but the shift from industrialisation towards services may result in a number of economic indicators failing to reflect growth in the new branches of the economy.” My sentiments exactly.

Few investors are aware that manufacturing and construction (the secondary part of the economy) has been surpassed by services and consumption (now the biggest tertiary part of the economy). Indeed, the latter accounted for more than half of  China’s GDP last year.

Even when things soured and the market fell, real retail sales were up by a slightly faster pace than in the first half of 2015. New home sales continued to rise. Passenger car sales were buoyant. I am not as pessimistic as others. China’s economy continues to be moving in the right direction towards a more sustainable rate of growth.

Further proof of a distorted picture comes via a quick appraisal of some of the indices available in the market. For example, the Shanghai Composite index comprises all A and B shares listed on the Shanghai Stock Exchange.

The index significantly overweights the old parts of the economy, such as the construction- related activities. It also overweights state-owned enterprises although privately owned companies account for more than 80 per cent of employment, thus driving job and wealth creation. The consumer and services sectors are very much underweights.

The announcement last year that 14 Chinese ADR stocks listed in the US, mainly IT services and consumer discretionary, are being added to the MSCI China index is pleasing. The IT sector is expected to become the largest sector weighting once the MSCI finishes rebalancing towards the middle of this year.

With all this in mind, an examination of index compositions is vital for investors interested in trackers. There are also other things to consider, such as the fact China’s vast domestic stockmarket is still mainly made up of local retail investors with little institutional participation – and still largely closed to foreign investors. Most funds currently invest in Chinese companies listed in Hong Kong.

Whether one is keen to access China actively or passively, it must be remembered how volatile these markets can be. A long-term investment horizon is important to weather the ups and downs.

Fund picks

  • The Allianz China Equity fund is managed by seasoned investor Christina Chung, based in Hong Kong. Chung prefers to take a longer-term approach when allocating to markets that are frequently momentum driven. She believes the strongest returns can be achieved from out-of favour companies, where their recovery potential is being ignored, such as those with a growth angle.
  • The Matthews China Dividend fund, managed by Yu Zhang and Sherwood Zhang, seeks to invest in companies that offer meaningful dividend yields, have sustainable business models and can demonstrate an ability to increase payouts over time. Dividends are a lens through which the managers can identify quality financially healthy companies with sensible capital allocation policies.
  • Fidelity China Consumer manager Raymond Ma has been running the fund since its launch in 2011. He seeks to identify the key beneficiaries of China’s emerging middle class, focusing on the “new China” consumer- related stocks.

Also in the Fidelity stable is Fidelity Funds China Focus, run by Jing Ning since September 2013. Ning’s value and contrarian investment approach centres on larger-cap stocks. The fund can invest directly in China A-shares thanks to Fidelity’s substantial Qualified Foreign Institutional Investor quota.

Amaya Assan is senior research analyst at Square Mile Investment Consulting and Research