The Chinese stock market had a strong year in 2017, outpacing both its developed and emerging market rivals. Stock market returns were around 35% in sterling terms, driven in particular by the strong performance of Chinese technology companies such as Alibaba or TenCent. But can it repeat its success in 2017?

There is undoubtedly much to like about the Chinese economy. Growth is outpacing expectations. The last reading showed the Chinese economy growing at 6.9% and the IMF expects further strong progress in 2018 and 2019. The recent strength of the currency also suggests that global investors have faith that Chinese growth will be sustained.

Darius McDermott, managing director of FundCalibre, also points out that the sheer size of China’s population gives it some natural advantages. “At around 1.4 billion people, is more than four times the size of the United States,” he says. “As China’s middle class expands (the number of middle-class households is projected to increase from 17% of the total in 2012 to 63% by 2022), the potential for consumer spending growth is enormous.  And China now boasts the largest e-commerce market at an estimated at $1.2 trillion. Consumption-related services account for 90% of the country’s GDP growth.”

Chinese infrastructure is improving – water, education, healthcare and sports. It is also a hotbed of innovation, with more Chinese companies being awarded patents.

However, it is not all good news. Russ Mould, AJ Bell investment director, says: “At barely 20% of GDP, China’s government debts are low, especially compared to the West, but it is running an annual budget deficit and its borrowings are rising. In addition, a lot of debt sits between the Government and the private sector within the State-Owned Enterprises, while the Communist Party is clearly becoming concerned about the extent of the private sector’s liabilities, too. Data from the China Banking Regulatory Commission show that total bank assets had reached $38 trillion by the end of 2017 – up from just $6 trillion a decade ago.”

At some point high growth is going to lead to some bad loans and poor capital allocation. It may also make it more difficult for China to continue to drive growth through fiscal and monetary stimulus.

Ben Kumar, investment manager at 7IM says: “We believe that the next 12 months for China are likely to see some volatility, as the government keeps undertaking structural reforms. Whilst these reforms are likely to be positive for a more sustainable level of growth over the long term, there is always the potential for short term negative surprises – whether in the equity markets, the property market, or perhaps some political disruption in some of the less well-developed provinces.

“Our exposure to China, outside of our multi manager funds, comes through the MSCI Emerging Market Index; China is 30% of this, and is likely to keep growing. Chinese equities have been incredibly strong performers over the last twelve months (with the consumer technology stocks such as Alibaba and Tencent seeing large gains), and we see no reason to be overweight the benchmark. We will be paying close attention to Chinese equity markets over the coming year, and should that situation change, we might well consider adding a specific allocation.”

Funds to consider

Fund Calibre’s McDermott recommends China funds for those wishing to take specific exposure to the country.

Fidelity China Special Situations

The manager of this trust is able to make use of Fidelity’s investment licences in China, which are among the largest of any international investor, offering investors direct exposure to the China growth story. Due to its bias towards smaller and medium sized companies in a developing market, it is not for the faint hearted, but those willing to take the risk could be handsomely rewarded over the long term.

First State Greater China Growth

The managers of this fund look for well-managed businesses with good corporate governance across Hong Kong, China and Taiwan. It has been a firm favourite of ours for a number of years. Martin and the team have shown that they can consistently produce the goods in any type of market environment.

Invesco Perpetual Hong Kong & China

This fund’s experienced team has the resources to visit companies on the ground and to do its own in-house research. This gives it a major edge versus many of its peers. The managers have a solid investment process, which focuses on fundamentals. They are not afraid to hold positions that are substantially different from their benchmark, which is dominated by old state-owned companies.