November 2015

INVESTEC GLOBAL INSIGHTS CONFERENCE 2015: Charting a path through China

ShanghaiDespite the volatility of the summer, China remains a great opportunity for investors that can take a long-term view. Investors should ignore the bad press that China has received following the sharp fall in its equities market in August. Instead they should stay focused on the long-term plans for the world’s second-largest economy by GDP. By adopting this approach, they will find a number of attractive investment opportunities. This was the message for attendees at the recent Investec Global Insights 2015 client conference.  China has created an inflection point for many investors as it continues its drive to open itself to international investment – the ongoing  currency conversion, the Mutual Fund Recognition scheme and the Hong Kong-Shanghai Stock Connect project are all coming to fruition and investors will need to tread with caution. However, this caution should be tempered with a sense of perspective regarding the events of August, where doubts about China’s reported growth figures led to a sharp fall in its equities market and talk of global contagion. “People have either ignored China or else got very worked up about it,” said Mike Hugman, strategist, Emerging Market Fixed Income at Investec Asset Management. What is important is to chart a path through the middle of these polarised approaches and to keep a consistent view.  Since 2010 there has been an effort to restructure the Chinese economy and to reduce the reliance on exports but, as the recent volatility has shown, many international investors have not kept this bigger picture in mind.  “The restructuring will be a huge and challenging process that will inevitably have some bumps in the road and will result in the deceleration of growth but some investors have forgotten this in their portfolio construction,” said Hugman. For example, even though the growth of China’s GDP has declined in recent months, the deceleration has been in line with many economists’ predictions. It should also be remembered that the rebalancing act has already gone quite far. The current account surplus has come down (in 2014 it was just 2.10% of GDP). In fixed income, China is currently in a sweet spot between growth and inflation, said Wilfred Wee, portfolio manager, Emerging Market Fixed Income, Investec Asset Management. And the valuations look very attractive when compared to the developed world. Chinese bonds are returning 1.8% more than developed market bonds and 1.4% more than BBB-rated US bonds, and with less duration. “You could comfortably clip the coupon in what would be a deflationary environment.” FOCUSED ON QUALITY
The opening up of the Chinese capital markets will also have an effect on the rest of the world, in particular its chairmanship of the G20 in 2016.  “For us in emerging market debt and fixed income, the impact of China rebalancing on the rest of the world keeps us focused on a low-growth, low-inflation market. So you have to stay focused on quality markets where you are sure the economic fundamentals will stay in place – something that needs to be stress-tested,” said Hugman. The long-term outlook for China’s equity market is also something that investors should consider, said Greg Kuhnert, portfolio manager for Investec’s 4Factor Equities, Asia team. “As the equities market slowly opens up, it will become very important. Right now there are only 170 stocks in Hong Kong but there are more than 2,700 in China’s onshore A-shares market. This is a big deal.” The domestic equities market is also driven primarily by retail investors who make up approximately 80% of the market, a factor that explains some of the volatility typically seen in the domestic market .  However, this profile is likely to change as the number of institutional investors increases.  Valuations are currently much more reasonable than they have been, said Kuhnert. A-shares are trading on a price-earnings ratio of 12, which is not excessive. Profits are improving for domestic companies and cashflow is improving across all sectors, which companies are using to pay off debt, which makes for more attractive balance sheets. “So ignore all the current bad press. Once this current correction has run its course, there will be some good opportunities.” The valuations for China’s A-Shares market look even more favourable if you discount China’s banks, said Kuhnert. “The market is pricing in a very negative scenario for the Chinese banks that is not supported by the facts. They all still have a lot of Tier 1 capital they can use before they have to consider any kind of recapitalisation. So I think there are some good opportunities there, although our fund is currently underweight on Chinese banks.” Kuhnert identified opportunities in both old and new stocks and industries. There is a rising middle class in China, so discretionary consumer goods, pharmaceutical and food are all sectors that will benefit. At the same time, primary materials producers should also be considered.  “This market is quite fragmented at present and this will lead to consolidation, which in turn will improve pricing power and grow shareholder returns, so it is a case of looking for those companies that will benefit from consolidation.” Investec Strategist Michael Power also reminded the audience that China’s plan to recreate the Silk Road, the trade route that once connected China to the Middle East and beyond, will have huge implications. “It is the Chinese equivalent of the Marshall Plan. It is a project that will inject huge infrastructure investment into various areas like Pakistan and some parts of Africa. Anyone that does not recognise this will mean missing out on good opportunities. The overwhelming spend on infrastructure will take place in Asia and the Indian Ocean over the next few years.” The last words on China went to Investec’s co-head of multi-asset, Philip Saunders. “The great worry among investors has been whether a China-related hit could derail the global economy. The markets have moved from the complacency about a managed China slowdown and a soft landing to now being extremely negative. Nobody is denying that there is a challenge. China is trying to create a modern capitalist sector and move away from a reliance on capital investment and exports. But there is not a crisis in China.” Optimism for new consumer markets in China is evidenced by the fact that express parcel delivery figures are up, he adds. Meanwhile, concerns about the collapse of China’s real estate may be misplaced, given that property stocks are currently outperforming other sectors. “It’s a mixed picture in China but our central case is that Chinese growth is starting to stabilise and we will see increasing evidence to support this,” said Saunders. ©2015 funds europe

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