Morningstar's "Perspectives" series features investment insights from selected third-party contributors. Here, Matthew Vaight, emerging markets fund manager at M&G Investments, comments on the outlook for China.
The macroeconomic situation in China continues to dominate headlines. Investors are preoccupied with the country’s growth rate, which slowed to its slowest pace in two decades in 2014, despite the Chinese government’s promotion of lower growth as the ‘new normal’. The tolerance of slower growth reflects the adjustment that is taking place as the government shifts from an economic model based on investment and exports to one based on consumption.
However, policymakers are trying to tread a careful path that involves providing modest stimulus measures aimed at entrepreneurs and infrastructure projects and ensuring the faltering property market and large debts do not overwhelm the economy.
In our view, China faces big issues with the shadow banking system and the level of non-performing loans. However, the government is looking to get to grips with the risk of bad debts. They have established asset management companies that take over the bad loans. This does not necessarily address the underlying problem of excessive lending and inefficient use of capital but we believe China can resolve these problems and avoid a crisis, or hard landing. The country has the financial resources to deal with the debts in the system and looks determined to do so.
China Offers Value
Against this backdrop we think there are opportunities in China as plenty of companies are priced with a crisis in mind. We believe there will be opportunities arising from the fact that China’s economy is in transition. The old model relied on low-cost manufacturing, but China is no longer a cheap place to manufacture as rising wages are eroding its competitiveness.
We are excited by the number of companies that are adjusting to this challenge. We see firms moving up the value chain and focusing on high-quality, sophisticated products. Many more firms are investing in research and development and brand recognition. By focusing on innovation and quality, Chinese firms can become globally competitive.
In the future, we expect to see more Chinese brands asserting themselves on the world stage. We have invested in Greatview Aseptic Packaging, a manufacturer of bacteria-resistant drinks cartons. Greatview is building on its success in the domestic market and seeking to expand overseas, particularly in Europe. Chinese companies that become successful domestically will already be established, large businesses, and are therefore able to use the benefits that size brings to help ease the transition to becoming a global player.
Non-State Owned Companies Favourable
We typically favour non-state owned companies like Greatview, which tend to be run by management teams that are focused on profitable growth and where there is an alignment of interests with minority shareholders.
We remain wary of many Chinese state-owned enterprises as we believe they are often run for the benefit of the state rather than minority investors. We do not hold any Chinese banks, for instance. In our view, they are not focused on capital efficiency and creating value for shareholders.
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