In this Q&A, Paras Anand, Chief Investment Officer, Asset Management Asia-Pacific, answers key questions around Covid, regulation and policy in China as well as the investment outlook. He highlights how there are potentially different perceptions of the same news flow between East and West given that economic and social models differ and concludes that the underlying drivers to China’s growth story remain in place.
Has China lost its advantage over Europe and the US in managing the Covid pandemic?
When the pandemic first began in Asia, many countries including China acted swiftly and aggressively and this was generally successful, with Asia first in and first out of lockdowns. More recently, the delta variant has led to a resurgence in cases in both developed and emerging markets. Because Asia is perceived by some as having slower and less effective vaccine programmes than Europe and the US, this has concerned some of the market. However, there is more nuance to the story.
We are seeing a range of Covid policy responses in Asia. Mainland China has administered more doses per 100 people than nearly all European countries and the US. Singapore, Malaysia and Hong Kong also have strong vaccination records to date. While Western Europe and the US have vaccinated more of their populations overall, leading Asian countries are in front. It’s also worth recognising that even countries slow to vaccinate such as Australia, progress fairly rapidly once its addressed.
In terms of vaccine efficacy, data for all the major vaccines are conflicting and affected by demographics, variants in circulation, dosage regimes and government policy. It appears emerging variants are a problem for all vaccines, but we are lacking robust data. As a result, some countries are modifying their immunisation strategies, although this is not unusual; for example, a number of countries including the UK restricted the use of the AstraZeneca vaccine after side effects emerged.
The most instructive data may be the number of infections. China had just 190 new cases in the week ending 31 August, compared to over a million in the US. While some Asian countries have had large spikes in infections in recent days, there are others with very few new cases.
In all, the Asian countries that managed the outbreak well during the first wave continue to make progress with inoculations and are containing the virus. This bodes well for their paths towards normalisation. Moreover, the development of the pandemic globally and the way borders are reopening suggest there will be more regional economic integration given travel corridors and supply chains. Finally, although we can expect continued local outbreaks, we are unlikely to see a repeat of the universal impact of Covid seen in the past 15 months.
Has China become a less friendly business environment?
China’s government spoke of “common prosperity” as a priority amid regulatory targeting of specific industries in the past year. This has concerned markets that China will be less business friendly than in the past. But this has likely been overstated. We don’t believe there is a paradigm shift in China’s government policy that will suppress the private sector. Instead, the overarching aim of recent regulation is to foster sustainable growth and boost social equality.
Regulatory intervention in China is not new and recent actions are not a significant departure from its historical trajectory. China has made substantial progress towards reforming its markets and aligning them with international standards over the past decade. Economic progress has been at the forefront of policymaking for much longer and there is nothing to suggest this has changed. Indeed, the Politburo recently emphasised that China is still a market driven economy, promised more transparent communication and pledged support for SMEs.
What China’s leaders have recognised is that as the country approaches global high-income status, income inequality has become increasingly stark. Household costs are a national concern, and recent government actions targeting the “three big mountains” - education, healthcare and housing - are consistent with that, more so given the low birth rate. Regulations towards major technology companies are somewhat separate and mirror interventions in Europe and the US aimed at promoting competition.
China’s goal to reengineer economic and social policies to achieve more sustainable growth could be positive in the long term and should free up household disposable income for private consumption, supporting the wider policy of transitioning towards a more consumption-led economy. This higher quality growth will offer investors better investment opportunities and it emphasises the need to understand sustainable investment principles as the costs of not considering societal and environmental stakeholders are high.
What is the investment outlook for China?
We are more likely to be at an inflexion point rather than a de-rating for Chinese equities. In the short term, there may be pressure on valuations as the equity risk premium remains elevated as international investors adopt a wait-and-see approach. In the long term, the outlook continues to be positive.
It’s instructive to look at China’s private education sector where the economics of certain parts have been reset, for example some areas of tutoring services will be not-for-profit. However, there is also a dislocation in equity prices with some education companies even trading below their net cash levels. Some of these companies will be able to adapt by changing their business models to capture some of the additional income saved by consumers.
Similar trends are playing out more broadly. In recent weeks, there have been patches of indiscriminate selling that have produced bargains, particularly among companies where growth trajectories remain intact. Investors should expect volatility in the near term and maintaining an active approach could help take advantage in areas aligned with the direction of policy such as green energy, semiconductors, new infrastructure, electric vehicle supply chains, AI and high-end manufacturing. Many businesses will also need to spend on compliance reporting, particularly those handling data. Understanding specific sector dynamics and finding companies with more sustainable business models or stronger pricing power will help investors identify winners and losers.
In the offshore market there are some deep value opportunities, while A-shares companies have less regulatory risk and could benefit from easier fiscal and monetary policy. Over time, we expect that the MSCI China universe will become more balanced around sector weightings with internet names reducing and industrials and IT rising.
Following the approval of the US Holding Foreign Companies Accountable Act (HFCAA), there is increasing pressure on ADR companies and a risk that Chinese companies will delist from US exchanges. While we view that as an extreme outcome, most large Chinese ADRs have secondary listings in Hong Kong and since ADRs and H-shares are fungible, delisting shouldn’t pose an insurmountable obstacle; Chinese regulators have also expressed a desire to resolve the dispute. The affair is likely to lead to more Chinese companies opting to list in Hong Kong, benefiting HKEX.
China’s market comprising of over 4000 companies and worth around US$12 trillion (comparable to the total value of EU markets) provides rich hunting grounds for contrarian investors looking beyond the typical tech names that feature most prominently in the media. Innovative companies are delivering strong growth and being actively supported by the government, and the pipeline of future investments is robust given the evolution of the STAR Board of innovative, growth-led businesses.
For long-term investors, prospects in China are still strong. Sentiment has largely taken a bigger knock than fundamentals, with concerns being driven less by the substance of proposed regulations and more by a lack of communication. If we recall events following June 2015 when Chinese equities lost a third of their value partly due to the extent of margin financing, today valuations are comparable, but markets are healthier with less margin and a greater proportion of institutional capital.
Despite policy headwinds in some sectors, the growth story is unbroken, new opportunities will emerge and China is on track to deliver solid GDP growth over the next decade, supporting the expansion of its middle class that should see its purchasing power rise as income gaps narrow.
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