By Jayson Forrest - Managing Editor - IMAP Perspectives
Francyne Mu - Franklin Templeton
Speaking at a recent IMAP webinar on international equities, Lachlan Hughes CFA (Swell Asset Management), Mark Arnold (Hyperion Asset Management), Tom King (Nanuk Asset Management), Francyne Mu CFA (Franklin Templeton) and Monik Kotecha (Insync Funds Management) provided their views on the opportunities and threats of investing in China.
China is shaping up to become the largest economy in the world, providing investors with seemingly untapped investment opportunities. Yet despite the irresistible growth of China, it remains a market that Mark Arnold - the Lead Portfolio Manager, CIO and Managing Director of Hyperion Asset Management - remains cautious about.
“At Hyperion, we think if you go into China directly, you’re going up the risk curve,” he says. “It’s our view that China is turning Japanese. China has an ageing population problem, it has very low population growth, and with GDP up 274 per cent, which has doubled over the last decade, we think the ‘super cycle’ is over for China.”
Add to this largely ineffective Government spending programs, high levels of corruption, no rule of law, limited intellectual property protection, and one party rule, and Mark believes they are all factors investors need to be consider carefully.
“We believe all these factors will impede future growth rates. So, we would question whether China will ultimately become the largest economy in the world. We just think it’s really difficult to invest in China.”
It is a view supported by the CIO of Insync Funds Management, Monik Kotecha, who believes that despite the considerable transformation of China over the last few decades, he believes China is now facing some considerable headwinds.
Monik agrees that the centralisation of power in China is stifling entrepreneurial growth, as the Chinese Government deals with a significant and widening socio-economic inequality issue between the rich and poor.
“Since the GFC, the export engine that China has previously relied on - low wages and a competitive labour force - has changed, as living and working standards have improved. China has an ageing demographic and it’s no longer as competitive as it previously was.
“A lot of the tailwinds that were previously there for China, are now starting to turn into headwinds,” Monik says.
“So, we believe that buying a broad-based manager that has a high exposure to China is quite a dangerous way to invest. Instead, you really need to be very specific in identifying sectors of the Chinese economy that have a competitive advantage, and look for ways of investing in these sectors.”
It’s our view that China is turning Japanese. China has an ageing population problem, it has very low population growth, and with GDP up 274 per cent, which has doubled over the last decade, we think the ‘super cycle’ is over for China
Not all doom and gloom
But despite this negative assessment, the CEO and CIO of Swell Asset Management, Lachlan Hughes CFA, doesn’t buy in to the ‘doom and gloom’ assertion of China, instead, viewing the nation of 1.4 billion people as a wonderful opportunity for investors.
“China is the world’s second largest economy and is set to become the world’s largest economy in the next five years. I think it’s very hard to bet against a country with 1.4 billion people who are working hard to make their lives better,” Lachlan says.
“In fact, I can see a situation in the next 15 years where China’s GDP on a per capita basis will get to one-third of the United States. At that point, China’s economy will be 40 per cent larger than the U.S. economy today.”
Lachlan likes the ‘China story’, and points to its next five-year plan, which includes promoting consumer spending and technology development. “China has a rising middle class. It’s building out digital infrastructure and it’s focused on high growth areas like microchips, IoT and 5G.”
However, Lachlan concedes there are issues around China’s regulatory system. Swell Asset Management has addressed this concern by investing in Chinese businesses, like Tencent and Alibaba.
“These two businesses are predominantly situated in China, and while they have some small operations outside of China, they are principally domestic Chinese businesses,” Lachlan says. “The Government in China has a very different relationship with local companies, compared to the U.S., and we saw this through COVID-19. The Chinese Government used Tencent and Alibaba to help stimulate the economy by distributing food vouchers to consumers via their apps.”
And while Swell Asset Management feels “very good” about China, Lachlan cautions that when dealing with companies like Tencent and Alibaba, investors need to be aware that despite these two companies being global behemoths, they are still heavily reliant on each other.
“The global supply chain is integrated and it’s very hard to decouple from this situation,” he says. “So, given the fact that Tencent and Alibaba both rely on each other, we believe the Chinese Government wants these businesses to succeed long-term, so ultimately, self-interest will win. We feel very good about China and our investments in China.”
Franklin Templeton shares a similar view to investing in China, with Francyne Mu CFA - Vice President, Portfolio Manager and Research Analyst for Franklin Equity Group - saying there are many interesting Chinese companies that investors can consider. But she adds that corporate governance remains an issue that needs to be considered when dealing with some of these companies.
For example, she says Franklin Templeton found it very difficult to invest in Chinese banks, given regulations on both the deposit and lending side of the banks.
“As an investor, we look very closely at our rights as a shareholder, and judge these opportunities on a stock-by-stock basis. We look at each company on their own merits to consider how this will impact business,” Francyne says.
“So, while the opportunity is there for international investors to tap into the Chinese consumer, the question going forward is whether or not there will be a wider opening of the Chinese economy that will put it on an equal footing with other economies. This will be a necessary condition for China if it wants to become a global economic super power.”
And what of the Yuan? While Francyne says China has been looking at the “internationalisation” of the Yuan, she concedes this will take time, meaning that until such time, the use of the Yuan as a payment settlement currency will lag far behind the U.S. dollar.
“Overall, we’re watching the developments in China carefully. However, the U.S. is still the most liquid and open market, and we believe investors will only go to those markets where they feel they have good access and where there is stability in the markets.”
A lot of the tailwinds that were previously there for China, are now starting to turn into headwinds.
If you look at the sustainability issues in China, it has a lot of environmental problems. However, China has expressed a serious commitment to fixing some of these environmental problems over time.
The CIO of Nanuk Asset Management, Tom King, believes that as a consequence of having developed its economy so quickly, there are a number of additional aspects investors should be thinking of when investing in China.
“If you look at the sustainability issues in China, it has a lot of environmental problems,” Tom says. “However, China has expressed a serious commitment to fixing some of these environmental problems over time.”
Tom refers to China’s recently announced 2060 carbon neutrality plan. If the People’s Republic is able to go remotely close to achieving that objective, Tom believes the implications will extend far beyond just renewable energy, having widespread ramifications in numerous sectors, including transport and manufacturing.
“And while we see opportunities in these sectors, many are difficult and challenging to access as a foreign investor and come with higher risks. Yet, despite this, we see China as a major player in the years ahead in many of the global sustainable technologies and supply chains,” Tom says.
“It’s a strategic imperative that China is pursuing in a way that’s much more aggressive than what we see elsewhere in the world.”
I can see a situation in the next 15 years where China’s GDP on a per capita basis will get to one-third of the United States. At that point, China’s economy will be 40 per cent larger than the U.S. economy today.”
So, while the opportunity is there for international investors to tap into the Chinese consumer, the question going forward is whether or not there will be a wider opening of the Chinese economy that will put it on an equal footing with other economies. This will be a necessary condition for China if it wants to become a global economic super power.
Francyne Mu CFA is Vice President, Portfolio Manager and Research Analyst for Franklin Equity Group. Monik Kotecha is CIO at Insync Funds Management. Tom King is CIO at Nanuk Asset Management. Lachlan Hughes CFA is CEO and CIO of Swell Asset Management. Mark Arnold is the Lead Portfolio Manager, CIO and Managing Director of Hyperion Asset Management.
They each spoke on international equities as part of an IMAP specialist webinar series on ‘International Equities in the current global market’.