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Written by: Darius McDermott
22/09/2021
First in, first out of the pandemic, China was expected to be the place to be for investors in 2021.

Having been lauded for its management of Covid, figures from the International Monetary Fund projected growth of more than 8 per cent for the world’s second largest economy – more than double anything offered in the developed world. Unfortunately, things are rarely that simple…

The long-term case for China can’t be disputed: I recently read that in the 10 years through 2019, China averages around one-third of global economic growth – larger than the combined share from the US, Europe and Japan. It is also an economy which is now consumption-led, with a rapidly growing middle class.

It is also meeting the challenge of urbanisation by building new cities based around integrated travel systems, 5G networks and cross-country travel. The current high-speed rail network is 23,500 miles of lines crisscrossing the country – that’s impressive given China had no high-speed railways at the beginning of the 21st century.

Clearly, it also has its challenges, most notably debt and demographics. The latter is incredibly difficult to repair, and the Chinese government is starting to show some signs of desperation, such as the recent switch to the three-child policy.

2021 a timely reminder of uncertainty

There is no doubt the positives outweigh the negatives, but investors have to remember that China always brings that element of uncertainty. This year has been a perfect microcosm of that, with all the positivity quickly undone as the market fell sharply.

Those falls have been driven by regulatory crackdowns, with China’s ruling party flexing its muscles and reminding everyone who is in charge.

The latest crackdown was an overhaul of the afterschool tutoring industry, banning companies from making profits, raising capital overseas or going public. Education is a highly competitive sector in China, and there were fears the heavy costs of afterschool tutoring would increase inequality.

There has also been a wider crackdown on other sectors – with tech a particular standout, amid government fears that the pace of innovation is faster than legislation. The concerns have been marked, with some of the big tech companies seeing their shares fall 35-50 per cent.

Should we be worried?

The truth is we should not be completely surprised, as the Chinese government is known for cracking down on various sectors from time-to-time. It’s also not the first time we’ve seen China hit with the ‘uninvestible’ tag – it seems to happen every three years or so. We had the US/China trade wars starting in 2018 and the implosion of the A-share market (shares of mainland China-based companies that trade on the two Chinese stock exchanges) in 2015.

The overarching worry is the threat this recent crackdown poses to foreign investors – and capitalism in general in China. Invesco China Equity manager Mike Shiao says history shows when regulatory actions are imposed, businesses do revert to normal – citing the gaming sector in 2018. He says the Chinese government has no desire to undermine a sector which is full of private companies which are a key pillar in China’s growth.

I agree with Mr. Shiao, but it’s a timely reminder that investing in China is a balancing act. We’ve considered adding to China given the market fell around 25 per cent from the peak in February. If you understand and appreciate these corporate governance risks, then the market is 25 per cent cheaper and the long-term story of growth – for what will become the largest economy in the world in the not-too-distant future – is a strong one.

Investors may want to consider the likes of the FSSA All China fund or the JPMorgan China Growth & Income trust for pure China exposure, while vehicles with an Asia-wide focus, such as Fidelity Asia Opportunities or Ninety One Asia Pacific Growth, offer a more diversified approach – both have a third of their portfolios in Chinese equities.

Darius McDermott is managing director of Chelsea Financial Services

 

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