How To Invest In China

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China is the second largest, and one of the fastest-growing, economies in the world but has largely failed to capture the attention of overseas investors.

While the eventual lifting of pandemic restrictions was expected to drive a recovery in the Chinese stock market, mounting headwinds have prompted a recalibration of investors’ expectations. Subdued domestic demand, regulatory concerns and a weak domestic currency led to a record low in quarterly foreign direct investment earlier this year.

That said, China may still offer an attractive investment opportunity for investors looking to diversify their portfolios. It boasts global corporate giants such as Tencent and Alibaba, and is forecast to have the second-highest growth in gross domestic product (GDP) over the next few years, according to the latest figures from the OECD.

We’re going to take a look at some of the benefits and risks of investing in China, together with the wider outlook for the sector.

Remember that investing is speculative and your capital is at risk. It is possible to lose some or all of your money.

How has the sector performed?

After an impressive bull run, the Chinese stock markets crashed in 2015 during the two days coined ‘Black Monday and Tuesday’. However, they steadily recovered their losses over the following years, as shown below:

By 2021, the CSI 300, comprising the 300 largest-cap stocks traded on the Shanghai and Shenzhen stock exchanges, hit an all-time high of over 5,800. However, share prices started to head downwards again as a number of factors conspired to dampen investor appetite.

Darius McDermott, managing director of FundCalibre, comments: “We had government intervention in a number of sectors such as technology and education, which – coupled with ongoing concerns about the property market and further strict covid lockdowns – led to widespread falls in share values.”

As a result, the Greater China fund sector has delivered a five-year return of just over 8%, compared to almost 50% for the global equity sector, according to Trustnet.

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The Chinese government’s relaxation of its zero-covid policy proved the catalyst for a rebound in stock markets in late 2021. However, this bounce proved fleeting, with stock markets continuing to slide as the hoped-for economic growth lost momentum.

The appeal for investors has also waned in light of a deterioration in international relations, along with the Chinese central bank easing monetary policy more aggressively than its Western counterparts. As a result, the renminbi recently fell to a decade-low against the US dollar, adding to the downside risk for foreign investors.

Mr McDermott adds: “In January, the market experienced a bounce as the reopening of the economy brought fresh hope, but it was short-lived. The Chinese have actually been quite cautious because they don’t have a social security system like we do, so they have saved and not spent.

“This, coupled with the increasing tensions between the US and China, means there just hasn’t been the pick-up many expected.”

Why invest in China?

China is the second-largest economy in the world thanks to its exponential growth, with the World Bank reporting that GDP reached $18 trillion in 2022. Put into context, this is almost six times the UK’s output and dwarfs Japan, the third-highest.

It’s also home to some of the largest global companies. Tech giant Tencent is the 21st largest company in the world by market capitalisation, with a current value of £300 billion. And drinks manufacturer Kweichow Moutai and e-commerce leviathan Alibaba aren’t far behind.

Although exports have played a key role in China’s economic success, it also has a burgeoning domestic economy. Dale Nicholls, portfolio manager of the Fidelity China Special Situations investment trust, points to a potential boost to consumption from the ¥30 trillion in household savings built up over the last three years.

And while there is still uncertainty over the future direction of government policy, the threat of further anti-corporation regulations seems to be receding.

Mr McDermott comments: “The government is working towards common prosperity but it can significantly impact share prices. We think there will be less of this intervention in the coming months as the government wants to get the economy back on track.”

Dzmitry Lipski, head of funds research at interactive investor, adds: “In contrast to major developed economies at the moment, inflation is not a key concern for China, and this allows the government to implement more accommodative monetary and fiscal policy measures.

“For these reasons, the recovery in Chinese equities should continue, considering relatively cheap valuations.”

What are the drawbacks of investing in China?

One of the key risks of investing in China is the regulatory environment. The Chinese government introduced a raft of heavy-duty regulations against technology firms in 2020, amid concerns over their influence.

The ‘Big Tech Crackdown’ led to swingeing fines, with the highest-profile casualty being Alibaba, hit for a landmark $2.8 billion fine on anti-monopoly grounds.

Investors may also have concerns over the country’s political regime, including the future direction of policy under President Xi Jinping and fragile relations with the US and Europe.

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Juliet Schooling Latter, research director at FundCalibre, comments: “Geo-political tensions are still high, but the rhetoric has been scaled down a bit. We’ve had a handshake between Biden and Xi, and there is the potential for a more pro-China party to come into power in Taiwan in its 2024 elections, so China upsetting its neighbours, at least immediately, is seeming like less of a concern.”

However, she adds: “Some of the damage has already been done with some manufacturing capabilities having been shifted away from China to more friendly nations: ‘friend-shoring’ is replacing offshoring.”

In addition, the US has warned Chinese companies that they may be de-listed from US stock exchanges if Beijing prevents regulators from reviewing audit records. This would substantially reduce the liquidity of Chinese shares, and have a knock-on effect on valuations.

What are the options for investing in China?

There are a range of options available, from investing in individual Chinese companies to broader-based Chinese and Asian funds.

1. Investing in Chinese companies

Chinese companies can issue different classes of shares, depending on where they’re listed and which investors are allowed to own them. There are two main options for UK investors wanting to buy shares in Chinese companies:

  • shares that are dual-listed on a US stock exchange, such as retailers Alibaba and
  • American Depository Receipts (ADRs), which represent a specified number of an overseas company’s shares and are denominated in US dollars, rather than renminbi. ADRs can be traded on US stock markets and include Alibaba and Tencent.

Looking at individual companies, Fidelity’s Dale Nicholls picks out Wuxi AppTec for investors considering adding Chinese stocks to their portfolio. Wuxi is a leading biotech contract development and manufacturing organisation (CDMO) in Asia and one of the dominant global platforms in terms of sales.

Mr Nicholls comments: “Wuxi is a long-term compounder expected to benefit from global pharmaceutical industry growth and continued research & development (R&D) investment by the pharmaceutical companies.

“Continued outsourcing trend from in-house production to CDMO companies, particularly in China, also underpins its position. WuXi has established a robust talent pool with strong technical skills which has helped to drive a loyal and sticky client base and the company recently reported upbeat financial results.”

Another company worthy of consideration is home appliance manufacturer Hisense Home Appliances Group.

Mr Nicholls comments: “The company has around 50% share of Hisense Hitachi, the number two central air-conditioning brand in China. While Hisense enjoys an industry tailwind from the cyclical recovery in the market, it’s also on track for margin improvement thanks to better incentives after the launch of an employment stock option plan in January.

“We think Hisense shows decent upside as the company still has multiple drivers in terms of market share gain in white goods and new business contribution with healthy order flow. Its strong year-to-date stock performance was mainly driven by real earnings per share growth instead of re-rating. If the market regains confidence in property (even a mild turnaround), Hisense can benefit in both fundamentals and valuations.”

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2. Investing in Chinese funds

Investing in Chinese funds provides investors with exposure to the sector through a ready-made, diversified portfolio of shares. Investors have the choice of actively-managed ‘stock-picking’ funds or passively-managed ‘tracker’ funds.

interactive investor’s Mr Lipski picks the Fidelity China Special Situations Trust which provides diversified exposure to stocks listed in both China and Hong Kong. He comments: “Dale Nicholls [at the Fidelity China Special Situations investment trust] focuses on faster-growing, consumer-orientated companies with robust cash flows and capable management teams.

“Due to the trust’s single country exposure, its bias to small and mid-sized companies and its ability to use gearing, its return profile is likely to be more volatile, making it higher-risk and an adventurous holding in a well-diversified portfolio.”

The trust has achieved a five-year return of 20% compared to a 7% return for the sector, according to Trustnet. It has also performed particularly well in the last year, delivering a top-quartile return of 4% against a fall for the wider sector.

FundCalibre’s Juliet Schooling Latter highlights the Invesco China Equity fund, commenting: “The manager aims to identify companies with a competitive advantage and sustainable leadership and specifically targets those he feels are undervalued by about 25-30%. He will then hold them with the expectation they will reach fair value over a three to five-year time horizon.”

The trust has achieved a five-year return of -3%, according to Trustnet, together with a top-quartile return of 1% over the last year, compared to a negative return of 8% for the IA Greater China sector.

For investors looking for a broader fund with some Chinese exposure, Mr Lipski picks the Fidelity Asia and Guinness Asian Equity Income funds, in addition to the JPMorgan Emerging Markets Trust.

What’s the outlook for investing in China?

Although the expected stimulus from the re-opening of the Chinese economy has been muted, investors will be hoping that the ‘bad news is priced in’. With a population of more than 1 billion (second only to India), China boasts a huge domestic market and is likely to remain an economic powerhouse.

Mr Lipski comments: “Overall, the long-term case for investing in China’s growth story remains intact. The growth of the middle class and the refocusing of China’s economy towards domestic consumption are expected to be key drivers of economic growth and the stock market in coming years.”

FundCalibre’s Mr McDermott agrees: “At the market level, Chinese equities are certainly cheaper than their long-term average, but not dramatically so. What we do see when speaking to managers is that they think there is incredible value in their portfolios.

“Clearly you need to be aware of the risks, geopolitical being the main consideration when investing in China. But some of these funds are now offering good value.”

Mr Lipski adds: “As China is increasingly recognised as being a major driver of global growth, investors should consider having exposure to China when building a balanced portfolio. China currently represents nearly 18% of world GDP but only 5% of world market capitalisation.”