After a period of strong outflows, we have seen renewed interests in China equities. Along with various structural developments, the asset class has continued to gain importance in global portfolios. In particular, MSCI, a key index provider that offers a number of benchmarks commonly used by Chinese equity portfolio managers, has added a number of US-listed Chinese companies to its indexes to enhance their diversity and better reflect the underlying growth drivers of the Chinese economy.
Some managers also held gold miners to hedge against global economic uncertainty
The investment themes of our favourite Chinese equity portfolio managers have dramatically changed over the past year. There no longer seemed to be a clear distinction between the “old economy” or “new economy” sectors when the managers think about their investment universes, and the hype about state-owned-enterprise reforms have somewhat diminished. In the current low-growth environment, many managers have instead strengthened their focus on, and have been paying a premium for, companies that have a higher certainty of meeting earnings expectations.
Consumers Continue to Drive Growth Opportunities
Domestic consumption continued to be a big theme among our preferred managers. Amid China’s objective to shift from an investment-heavy to a domestic-consumption-driven economy, rising domestic income and lifestyle upgrades are all conducive to long-term consumption growth. That said, the theme encompasses a diverse range of subindustries and not all consumer stocks can deliver earnings, such as shopping mall operators.
As a result, managers have been very selective in identifying consumer companies that would best benefit from the structural shift. E-commerce companies have continued to erode traditional retailers’ market share over the past year.
Along with a number of US-listed Chinese Internet companies being included in the MSCI emerging-markets indexes, online retailers have been more and more prominently featured in Greater China portfolios this year. A favourite was market leader Alibaba (BABA), which has been loved for its a well-established ecosystem, asset-light business model, and successful online payment system. Although it is one of the more richly valued stocks in the sector, some argued that the valuation is justified given the firm’s ability to deliver earnings on the back of robust gross merchandise volume growth.
On the other hand, mall operators have been described as value traps. The auto sector has been growing at a faster pace than the Chinese economy, and there has been no lack of proponents for the sector at both the upstream and downstream levels. The spotlight was on companies with large exposure to sport utility vehicles segment, as SUV sales in China have continued to gain momentum. In addition, we have seen some interest in passenger vehicle manufacturers, such as bus and minibus manufacturers with a strong product pipeline.
Information Technology Leads the Way
Internet giant Tencent (00700) remained a market darling given its dominance in online gaming, sticky user base, and accelerating monetisation of online advertising. More interestingly, some managers liked social media platform Weibo, which has revamped to become more entertainment-centric and attracted a large, young user base, again presenting monetisation potential.
Other than the internet-related names, Taiwanese hardware companies were a focal point. As one of the world’s largest semiconductor foundries, TSMC’s technological leadership and cost advantages made it an appealing choice. Nonetheless, concerns about plateauing smartphone penetration has prompted some managers to invest in design-intensive, niche technology companies that are more resilient to Chinese competitors.
AAC Technologies, which has been growing its core acoustics business and expanding into haptics, and Largan Precision, a camera lens producer with patent technology, were among the most discussed stocks.
What About Financial Stocks?
Chinese property developers have been popular as the government has been supporting the sector with favourable policies, such as lowering the minimum down payment for first-time home buyers in most cities. A couple of state-owned developers that focus on first-tier cities, namely China Overseas Land and Investment and China Resources Land, have been of particular interest, as large cities such as Shanghai and Shenzhen have seen soaring home prices and healthy destocking over the past year.
Their access to cheap onshore funding and efforts to reposition away from US-dollar-denominated debt further adds to their investment merit. An interesting observation was the increasing bifurcation of the Chinese real estate market. While the first-tier cities’ housing markets have been booming, the lower-tier or smaller inland cities have had a rising stockpile of unsold homes. Some managers believe that this poses an uncertain policy environment, as the government balances between spurring growth and avoiding bubbles.
Consequently, we have also seen some managers reduce their exposure to the sector.
While there have been divided views on the property market, many managers have pared back on their Chinese insurance holdings. Although the structural story of rising demand for protection-type products and an underpenetrated insurance market persists, managers were concerned about the decline in bond yields eroding the spread that insurers earn from reinvesting insurance premiums into bonds.
Furthermore, certain insurers have been aggressively selling high-guaranteed-rate products, which have made them invest in higher-yielding, but also riskier, corporate bonds. Therefore, some managers have instead played the theme through the more richly valued Hong Kong-based insurer AIA Group, which has delivered steady and strong growth in value of new business, particularly in Hong Kong and China.
Materials and Commodities
Investors have avoided the materials sector for the past few years because of overcapacity issues. However, the government’s efforts to curb oversupply and reduce leverage have resulted in some industry consolidation plays in select subsectors, such as paper and cement. Some managers also held gold miners to hedge against global economic uncertainty.
Following the plummet in oil prices, we have observed a number of managers top up their oil exposure given their expectations of supply-side improvements, oil price recovery, and the oil companies’ beaten-down valuations.
Given the market volatility and a low-growth environment, many managers have increased their emphasis on companies with strong fundamentals and good earnings visibility, but they also found select value opportunities with turnaround potential. Now more than ever, it is important to invest in portfolio managers with the experience and investment savvy to navigate such difficult waters.
