Holly Cook: 2013, according to the Chinese Lunar Calendar, is the year of the Water Snake, associated with cleverness and tenacity but also with the potential for turbulence. To help us decipher this interesting area of investment, I’m joined by Philip Ehrmann. He is Joint Head of Far Eastern Equities at Jupiter and also manages multiple China equity funds.
Philip, Ni Hao!
Philip Ehrmann: Hi, very nice to be here.
Cook: So, China is obviously one of the global leaders of economic growth around the world. But it’s only really been in the last few years that people have really started to look at it as a mainstream area of investment. What’s changed in recent history?
Ehrmann: Well, effectively in the last 10 to 12 years, the Chinese economy has begun to broaden out, and the stock market has become much more investible. Previously, the only way really in was to buy Hong Kong listed trading companies that tried to capture some of the raw growth that was coming from the export sector, which was initially China’s primary driver to economic growth.
Cook: So, in terms of what is so attractive about this area, are there particular characteristics that mean that people want to be tapping in to Chinese growth?
Ehrmann: Well, we are at a very interesting inflection point. We have the Chinese economy moving to the next stage of economic development where you are getting a lot more domestic consumption, which is seeing investment in consumer service companies, technology and basically a roll out of things that we take for granted in the West, essentially China’s industrial revolution being played out in front of our eyes. So, that becomes very, very interesting, and we’re now getting a wider range of more entrepreneurial companies, less dominated by big State-owned enterprises, but much more entrepreneurially driven.
Cook: So, in terms of actual sectors – and I know that you have been in China very recently and I was there at the end of 2012 – the one that seemed obvious to me was construction, so much construction going on, so much infrastructure being built. Are there particular sectors that you would look out for when looking to invest in China?
Ehrmann: There are. I mean the first thing to say very briefly is that China is not a homogenous country. There are all sorts of things going on in different regions. And property and construction as you mentioned is a very good case in point where you can have completely contrasting experiences from very large cities like Shanghai and Beijing, from some of these smaller third and fourth tier cities where there are only 1 million or 2 million people leaving. So, China has about 140, 150 cities with more than 1 million people leaving in them. So, there is a lot going on.
But the sectors that we find most interesting, as I say, are some of the newer areas, the elements that are going to be the building blocks to China’s sustainable growth going forward. So, they would relate to energy efficiency, increased productivity, education, healthcare, many of the important planks to the government’s policies.
Cook: So, how about on the flip side the sort of cons associated with investing in China? I mean, there is an element of political risk and perhaps some of the plans to build the super cities might not play out in the way that they predict. What would you say are the key risks that you need to be aware of?
Ehrmann: Well, funny enough, the political element is one that I would actually downplay. We have just come through a very political year where we had a changing of the guards. So, the once in a decade change in politicians and the people leading the country has taken place against quite an interesting backdrop. There has been a lot more disclosure for what has in the past seemed to be a rather closed system.
In terms of the economy, it’s probably got more to do with trying to rebalance the economy, put it on a firmer footing, putting in place many of the reforms. The last four or five years have been rather clouded by what China did to avoid getting sucked into the same downward spiral as the rest of the world.
China put in place a massive fiscal stimulus and unwinding that has rather dominated the stock markets and the financial markets over the last few years. But it should be pointed out that at the bottom of China’s economic growth, which was probably reached in the third quarter of 2012, the economy was still growing at over 7%.
Cook: So you mentioned the economic slowdown and that was partly responsible for the volatility that we have seen recently. I know 2009 was really a tremendous year if you were investing in China equity whereas 2011 was a pretty horrible year; so far this year, it is looking pretty good again. You do need to be able to stomach this volatility, if you want to be investing in this area, don’t you?
Ehrmann: I think that’s true of many if not all emerging markets. We haven’t really got to the stage yet where China has what I would call an institutional heart in terms of investor base. That will become very important. It’s occurring, but at the moment the volatility really reflects – the fact it’s much more of a retail environment and boom-bust seems to be much more on the agenda. I would also just say very briefly, of course, that everywhere in the world, the last three or four years have been quite extraordinary, and risk on and risk off has created a rather volatile backdrop for all of us.
Cook: So, in terms of asset allocation, I was talking to a Morningstar viewer the other day. He said that with China accounting for something like 40% of world growth, it was going to be 40% of his portfolio. Is that kind of view one that you would agree with?
Ehrmann: I think a health warning has to be put in place here, as is always the case.You need to obviously look at your own circumstances. I probably have more in common with your viewer, and I really do believe that not just China but other areas of Asia, India, Indonesia growing very, very rapidly, and you can feel the shift from the West to the developing world happening in front of our eyes.
However, we need to be a little bit careful that we don’t write off some of the very, very good companies in the West. The United States stock market has been very strong for the last year or so as cash flows have been strong, companies have made acquisitions, buybacks of stocks, and of course, many western countries and companies investing directly in China and the Asian region. But as I say, I think that there is quite clearly a shift occurring and huge opportunity for investors in the region.
Cook: So some people might say China is no longer an emerging country, it’s essentially emerged and perhaps the story is shifting elsewhere, but it sounds very much like you are saying this really is a big area for some time to come?
Ehrmann: Absolutely. There seem to be from my perspective some very, very material reforms that need to be put in place. We are only beginning to see some of the benefits of what I’d call industrial revolution playing out in China, and I think that will begin to accrue to investors in terms of increased productivity and profitability from companies.
Cook: Well, Philip, thank you very much for joining me, and let’s hope for a prosperous year of the Water Snake.
Ehrmann: Thank you very much.
Cook: For Morningstar, I’m Holly Cook. Thanks for watching.
