China equities: not a comeback, not a setback

July 12, 2023

We give an on-the-ground perspective on China’s struggling economy, and discuss why we believe that selective investing is key to navigating this often-misunderstood asset class.

China’s much-prophesised economic recovery slowed from April this year, with retail, investment and property sales figures falling short of expectations1. Rapidly worsening exports, a high youth unemployment rate, the end of the property boom, and weak domestic demand are contributing to foreign investors’ concerns, and many are asking questions around China’s ‘investability’.

Yet on the ground, we see several reasons for optimism. Experience consumption, such as spending in hotels and restaurants, is faring well, while at the other end of the scale, ‘trading down’ is a theme where we’re seeing investment opportunities. It is also worth noting that employment in China’s service sector began this year significantly short of where it would have been prior to Covid. The rebound in service industries should restore a wealth of jobs over the next year, and when these jobs return, income and spending will revive.

Policy-wise, the government has stepped back from its interventions in property, tech and pharma, as well as some parts of the financial sector, and regulation has moved into an easing cycle. We believe the coming years will see a moderate and friendly policy environment, and this should benefit China’s equity market.

To our minds, a challenging social and economic landscape can give rise to selective investment opportunities, and we believe that investing successfully in China equities requires an active, bottom-up approach. The asset class can be a volatile one, yet as the world’s second-largest economy, it enables access to an immense opportunity set. Based on fundamentals, we believe there is significant upside, and now could be a timely moment to start carefully building exposure.

Our high conviction portfolio of 45-50 businesses is built on rigorous due diligence, long-term industry perspectives, and ESG integration throughout the research process. We provide exposure to China’s growth story but differentiate ourselves through the bottom-up work we do as a team to find what we believe to be the best businesses.

Speaking to corporate executives, policymakers, industry experts, think tanks and research institutions is a key feature of our approach. Importantly, we balance this local insight with industry expertise and regional perspectives to gain a differentiated view on China’s dynamic changes. The cross-regional structure of our 11-person investment team is testament to the importance we place on a holistic perspective.

We test financials for integrity and the sustainability of cash flows early in our investment process, and we eliminate those with low sustainability scores. ESG materiality is a key consideration, and team members act as specialists in their respective fields, allowing for a better understanding of key ESG controversies within each sub-sector or market. Regional expertise allows for a lifecycle stage view of business models, based on learnings from other parts of Asia.

Geopolitical tensions continue to exist, and our best defense is to be nimble. We analyse potential scenarios before entering a position, and we are mindful of liquidity and the ability to exit in a timely manner. For each of our investee companies, we look at dependence on the US for both revenue (output reliance) and technology (input reliance).

Within renewables, for example, we see investment opportunities around solar energy growth and electric vehicles, as these two segments of the market have little input reliance on the US and, if anything, are strongly depended on by other countries. Conversely, the apps TikTok and Temu are currently under scrutiny from the US government yet are hugely reliant on its market and need to ensure they don’t lose business share in the US. We also see a plethora of companies between these two extremes, where we continue to find worthwhile investment opportunities.

Overall, we believe that the risk-reward for China equities is attractive. The market remains under-owned by foreign investors and is currently trading at attractive valuations. With these valuations not pricing in long-term potential, the time could be right for investors to benefit from the asset class. We pick companies that we believe will benefit from China’s changing stories, and we tune out the market noise.

1 ‘China’s economy is on course for a “double dip”’ (The Economist (June 2023)).

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