Are you optimistic about the year ahead?
Definitely. Decisive action on the Covid-19 virus has supported economic recovery in China. Small localised outbreaks have been dealt with deftly and without denting economic momentum. This is reflected in forward-looking economic statistics (such as Purchasing Managers’ Indices), which have recovered well ahead of other Asian and Western peers. 1
Good performance from the services and exports sectors buoyed economic growth in the June to September period, with GDP rising 4.9%. The fourth quarter GDP figure of 6.5% exceeded expectations as key laggards in the service sector – travel and leisure – are gaining momentum.
Government stimulus has helped, but overall has been more restrained and targeted than measures seen in most Western economies. This gives the Chinese government some remaining firepower if the Covid crisis reignites.
Chinese markets have ticked higher as investors have recognised the country’s stronger economic performance. Nevertheless, share prices continue to be at a significant discount to the US markets, despite arguably better growth prospects.
The return to “normality” in China should mean lower risks relative to those countries still struggling to get the virus under control. We still see many companies left behind by markets offering significant value.
Which risks are you monitoring most closely?
Geopolitics and capital market reform are two areas to monitor. Throughout the year we have continued to see tensions rise between the US and China. These tensions are entrenched, but a more measured approach from the US side is likely under the new administration.
While the portfolio is largely focused on opportunities supported by ongoing structural shifts in China’s domestic economy, this is a useful backdrop.
Capital market reforms in China include the loosening of short-selling restrictions, the lowering of foreign investment restrictions and the implementation of a registration-based IPO mechanism.
The registration-based IPO mechanism was launched last July on the STAR Board (the science and technology innovation board of the Shanghai Stock Exchange) and is now being employed on ChiNext. In these markets, listing criteria are also more flexible, and we believe this will encourage more tech and new economy companies to list on the A-share market.
Looking ahead, we believe further expansion of these reforms to the broader A-share markets would be positive for Chinese markets. We have already seen more IPOs of A-shares and Red Chip companies this year and there could be more to come given more flexible listing requirements and some interest from US companies
That said, as always, we do need to follow regulatory developments closely. Recently we have seen draft regulation in the fintech space that delayed the hotly-anticipated Ant IPO, plus there are some anti-trust rules brewing in the technology area. We don’t sense that these will change the outlook significantly for the large technology companies, but developments certainly need to be monitored.
What themes, sectors or regions stand out as offering opportunities in a post Covid-19 world?
Our focus is firmly on ‘New’ China. That means steering the portfolio towards sectors that will grow their share of the economy over time, particularly among the consumer-related, technology and healthcare sector. In many of these areas, Covid-19 has super-charged structural trends already underway in China.
E-commerce is a particularly compelling theme. Many consumer goods in China have real capacity for growth and we see a trend towards upgrading and buying premium brands.
Within financials, we are particularly interested in insurance. ‘Protection’ type life insurance is only lightly used and we believe demand will naturally rise with higher incomes. Covid-19 could accelerate demand as people look at ways to protect themselves and their families from future crises. This would benefit areas such as health insurance.
Sustainability is becoming increasingly important for investors. Is it possible to invest sustainably in China? And how is this reflected in your portfolio?
Chinese companies are improving their sustainability footprint all the time. Sustainable investing remains a core part of our investment process and we believe that high standards of corporate responsibility make good business sense. It helps manage risks and it has the potential to enhance returns We integrate Environmental, Social and Governance (ESG) issues into our research and investment decision-making process.
We favour engaging with companies to improve their behaviour, rather than excluding companies from the portfolio. This can bring long-term changes, adding value for companies, our investors and society. Our recent ESG engagements have included areas such as supply chain sustainability and how companies can improve their reporting on sustainability issues.
Based on our internal ESG ratings, around three-quarters of the portfolio is currently invested in companies that rate highly from a sustainability perspective. While most of the remainder are not rated, this portion has been falling as our ESG research coverage expands.
Within your portfolio, where do you have strongest conviction and, in contrast, which areas are you avoiding?
We judge the underlying value of companies through an assessment of their growth prospects, underlying competitive strengths and the quality of management teams. We tend to find companies that meet our criteria more often among smaller companies. As long as these companies can execute well and deliver on their promises, growing earnings over time, this should ultimately be reflected in stronger share prices over time.
As well as those companies geared to China’s long-term structural growth story we mention above, we are also finding opportunities is in the materials space in China. This incorporates several sectors that are still fragmented, but where signs of consolidation are underway. We are focused on the leaders emerging from this process. Examples would be in areas such as paint and floor tiles.
More generally, given the strong run in markets - notably in technology, healthcare and staples sectors - value is becoming harder to find, but there are still overlooked opportunities, especially among small-cap companies. For example, many healthy, fast-growing Hong Kong-listed small-caps still at single-digit PE ratios. We see real opportunities ahead as China emerges from this crisis.
Source: Bloomberg News as at 30.11.2020
Source: Fortune.com as at 19.10.20
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