The power of endurance
Markets are rather nervous on account of China’s zeroCovid policy and the harsh measures implemented by Chinese regulators. Nevertheless, there are a lot of arguments in favour of Chinese equities in the long term. To put it simply, there are eight good reasons to invest in Chinese equities.
1 Climate Bond Initiative, “Climate investment opportunities …”, July 2021
2 Allianz Global Investors, “How China can achieve…” August 2022
3 Oliver Wyman, “China has a unique edge …”, November 2021
4 International Association of Accounting Professionals, “China puts focus on improving (…)”, December 2021
5 World Intellectual Property Organization, “World Intellectual Property Organization (…)”, November 2021
The power of the environment
Many investors have been nervously watching the volatility in Chinese equity markets, and their worries are understandable. But these ups and downs seem to be because of a few macroeconomic and geopolitical issues that appear unlikely to derail the longterm investment case for China. The economy may have slowed since mid-2021, but recently there has been a clear pivot to policy aimed at supporting economic growth. We expect that support to gain traction in the coming months. China equities typically track domestic liquidity closely, with potentially improved stock market performance following periods of increased access to credit. With the China Credit Impulse Index, which measures the credit cycle in the market, already picking up in 2022, we anticipate more stable market conditions as the economy is lifted by greater government spending and the outlook for corporate earnings improves. At the same time, an expected easing of some of the more restrictive Covid-19 measures should allow the benefits of policy easing to come through.
Enticing foreign money
Despite the negative news out of China, global investors have continued to add China A-shares (stocks of Chinese companies listed on exchanges in Shanghai or Shenzhen) to their portfolios. March 2022 marked the first instance of net selling in 17 consecutive months. The Chinese government helped lay the groundwork for greater cross-border investment with the launch of the Shanghai and Shenzhen Stock Connect schemes in 2014 and 2016, respectively. In “southbound” trades, mainland China residents use the Shanghai or Shenzhen exchanges to buy Hong Kong-listed stocks. Investors outside of mainland China can use the Hong Kong exchange to buy A-shares in Shanghai or Shenzhen (known as a “northbound” trade). China is expected to stay committed to further opening its markets to foreign investment in the coming years.1
China intends to be net-zero by 2060, i.e., no longer emitting any carbon dioxide.2
NOBLE OBJECTIVES, HIGH COSTS
A lot of money is needed to achieve climate neutrality globally: between 2020 and 2030 alone, demand is likely to triple.3
Size underestimated
Despite China’s growth and ambitions, we believe its significant economic potential is not fully reflected in global equity indices.In fact the discrepancy between traditionally low portfolio allocations and China's economic strength and market size is a key reason for the long-term upward trend in foreign investment in Chinese A-shares. As at 31 December 2021, the MSCI AC World Index had a 61.3% allocation to the United States and just a 3.6% allocation to China. As China’s capital markets become increasingly integrated into the global financial system, we believe this gap should narrow. And over time we expect that global investor allocations to China should continue to increase, in line with China’s growing economic influence.
Not keeping pace with the rest of the world
China’s equity markets can be useful as a portfolio-diversification tool. A-shares have a correlation of 0.31 with global equities over the last 10 years, which means they move in different directions almost 70% of the time. In comparison, US and global equities have a correlation of 0.97. Therefore, holding China A-shares in a global portfolio may help generate a better overall risk-return profile.
More surprises, more opportunities
Investing in China brings different risks and greater unpredictability compared with Western markets. The Chinese government’s clampdown on the internet platform and property sectors in 2021 – and the subsequent economic slowdown – illustrate this point. But investors have historically been rewarded with long-term outperformance. Hypothetically, an investment in the MSCI China Index in the period from the end of 2000 to 30 April 2022 would have generated a 418% return in US dollar terms, more than double the return from European equities (MSCI Europe Index). In the past, moments of volatility like those seen recently have proved to be buying opportunities for many long-term investors.
Bad news? Already priced in!
Chinese equities, both onshore China A-shares and offshore stocks listed in Hong Kong, are trading at valuations below the historical average. That suggests much of the negative news surrounding the economic slowdown is already priced in. Within the market, we see the pullback in recent months as a buying opportunity on a longer-term perspective for a growing number of high-quality stocks.
By 2025, China’s big-data industry is expected to be worth USD 471 billion – three times the 2020 level.4
Innovation + transformation = growth
China has come a long way in a short time. Once known as the “factory of the world”, it has shifted away from low-cost manufacturing towards the high-tech areas that are essential to its growth – and self-sufficiency. China is seeking to increase its level of self-sufficiency in critical technologies of the future such as semiconductors and other strategically important areas like domestic energy supply. A rapidly expanding middle class, increasing domestic consumption and high-tech innovation are all key ingredients of the China growth story.
In 2020, 2.5 times more patent applications were filed in China than in the USA.5
Anything but a “one-trick pony”
There are many ways for investors to buy shares of Chinese companies, with the capital markets much broader and deeper than many investors realise. This has become even more important during China’s recent regulatory clampdown, which impacted some listings more than others – particularly US-listed American depositary receipts (ADRs) and select Hong Kong-listed companies. Investors also have access to a diversified range of sectors. Structural growth areas such as industrials, technology and materials are concentrated onshore, while internet and other traditional sectors such as real estate, utilities and energy are better represented in the offshore space. The multiple ways to invest and diversity in sectors are among the reasons why Chinese equities may provide an attractive investment option.