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The changing face of China

25 Oct 2018

Portfolio Manager Wenchang Ma discusses the investment case for China and why we can expect to see continued trade war tensions with the US.



Lindsay Williams: With me now is Wenchang Ma, who is a Portfolio Manager for Investec Asset Management based in Hong Kong and she recently wrote a piece, a presentation, in fact, called The Changing Face of Asia and China. Wenchang, thanks for joining me.

Asia is Innovating – this is the most impactful slide that I saw right at the beginning because it talks about research and development (R&D) and the amount of money that those two regions (Asia and China) are spending compared to the rest of the world. Also the patent data quite extraordinary.

Wenchang Ma: Yes. I think China does have a very strong case in terms of innovation. In China, there is a large consumer base and that consumer base is also getting wealthier by the day. At the same time, we do have very efficient supply chains.

For people who have been to China, I am sure you have seen the logistics and the infrastructure that we have on the ground in the country that is very, very supportive of innovative companies to sell their products around as well. At the same time, there is an abundance of private capital, partly due to the fact that China still does not have a completely open capital account so a lot of the private capital are trying to look for opportunities to invest inside the country. Apart from all this, there are very supportive policies from the Chinese government.

So all of those are helping to boost innovation inside the Chinese economy and, actually, if we just look at the R&D spending as a percentage of GDP, China is running ahead of the Eurozone in average.

Lindsay Williams: What about the risk though, Wenchang? I mean I have just seen over the last couple of days on international televisions stations, with great fanfare, the opening of the world’s longest (I think) over the water (if that is the right phrase) bridge, linking Hong Kong where you are and the Chinese mainland. US$20 billion I think was the total cost and that sort of raises a few risks I think because that is an awful lot of money and that sort of says something about the incredible expansion. Is there a debt risk?

Wenchang Ma: The debt risk has always been on investors’ minds when we look at China and I think it is a very serious concern and it has to be quite high on the priority list when we analyse the risks in China going forward.

So if we look at the overall debt situation, over the past, it has been building up, especially during the Financial Crisis when China was trying to stimulus its way out of recession from a global perspective. That really had pushed up the debt level overall inside the country but what the government has been pushing over the past few years is the supply side reform and very stringent environmental control and that has actually pushed out quite a lot of excess capacities in all the economies and made the companies who managed to stand stronger from a financial perspective. So margins have got higher, cash flow has improved, they managed to pay down debt and the overall leverage situation in China’s old economy has improved and that is where China’s debt risk was the highest over the past.

So the result is that in 2017, beginning of 2018, we have continued to see the overall corporate leverage being stabilised to slightly going down and banks’ NPL ratios have actually not been increasing. So, overall, the debt situation continues to be a risk for the long term but that looks quite manageable from where we stand now. As long as you still have solid corporate fundamental earnings growth and cash flow situation, capex being maintained under discipline, I think overall the situation should be manageable.

Lindsay Williams: What about economic growth? We had a recent GDP print from China and some people in the west seemed to be rather disappointed by that. What do you make of it?

Wenchang Ma: I think it is always a bit dangerous trying to sum up China with just one single number, especially if it is just the GDP growth number because China is such a vast country and, if you are looking at the top tier city or the second tier city versus the third and fourth tier city or the rural area, the picture is completely different. So I think using just one number trying to sum up the entire China would be mistaken and would be easily missing out the opportunities that are on the ground.

So we need to take a fundamental bottom-up view, look at individual companies, what kind of growth opportunities there are, the quality of the business, operating momentum and also the valuations. Those are the key drivers of long term performance on the equity side. It is not actually the macro drivers. Often when people look at the policy news headlines, all those kind of noises can create quite a bit of volatility in the short term but in the long term I think we should look through the noises.

Lindsay Williams: Talking about equities, you make a very bold statement. You say China A-shares represent a once in a lifetime opportunity. What then is your case for China A-shares?

Wenchang Ma: Well, China A-shares are trading very cheap. At the moment they are trading at below their 10 year historical average in terms of the valuation and also very, very cheap compared to the developed market, no matter if you compare it to the US or to Europe, and especially attractive when you compare it to the growth that it is presenting as an aggregate versus these other markets.

On the A-share market side, we are seeing quite a lot of the global investors are looking increasingly at China A-shares and that is partly pushed by the index inclusions announced by MSCI and also by FTSE Russell. Both indices are increasing their inclusion of China A-shares. For MSCI, they are looking to increase the inclusion factor from 5% to 20% next year and for FTSE Russell, it is going to be the first time that they include A-shares into the emerging market benchmark index next year. As a starting point, China A-shares will already account for about 5.5% of the emerging market index of FTSE Russell.

So that is quite substantial and the inclusion of these indices are going to trigger passive flows into the A-share market and active flows are already looking at positioning and some of them will also follow the passive flows afterwards, depending on the asset managers’ individual strategies on the region but, either way, the trend is very clear. So global investors as a group will not be able to continue to ignore China as a market in the future.

So people look at the growth perspective of this market, the cheap valuation, index inclusion trend and also the diversification benefit that China has to offer versus the rest of the equity market globally and I think people see the opportunities in this market and are thinking about making the allocation using a more serious strategy.

Lindsay Williams: We can’t have a chat about the Chinese economy or the case for Chinese equities, whether it be A-shares or whatever, without talking about the so-called trade war which was initiated by Mr Trump. Does it worry you? It doesn’t seem to worry a Chinese official, who recently said “we don’t fear a trade war”. Do you fear it?

Wenchang Ma: I think the trade war is probably something that we have to be ready for for quite a long period of time because, if we look at what has been driving this conflict between the US and China, it was actually the “Made in China 2025” initiative where China has announced that it wants to be the global leader in quite a lot of these very important strategic areas, be it robotics or high-speed rail, internet and healthcare, etc.

So in all these areas China is taking up a more and more strategic importance globally and that is a challenge for US in its traditional global strategic position. So I think the conflict lies deeper than import and export and the trade conflict is probably just a window to reflect this longer and deeper conflict between the two countries.

So there is a risk that this may actually last longer than the current year and at the same time I also think that the trade war presents a certain degree of opportunities for China in the sense that China at the moment is pushing for quite a lot of reforms and also we have talked about innovation happening on the ground in China. With the trade war being a threat to economic growth, I think China is probably very likely going to accelerate in some of these reforms and also push forward with its innovation efforts.

Lindsay Williams: Your last two points in your conclusion are very simple points and I like simplicity. You say: “Asia remains cheap relative to the rest of the world” and you also say: “Investors remain underweight Asia, which should provide further room to outperform”. It is a nice way to summarise it – it’s cheap.

Wenchang Ma: Yes, China overall is still very, very cheap. From a valuation point of view, it is trading at below its 10 year historical average and, if we look at it from a forward-looking price-to-earnings metric, it is trading also cheaper compared to Europe, compared to US, despite the more attractive growth profile. So the valuation argument is quite strong for China at the moment.

Lindsay Williams: Wenchang, thank you very much for your time. That is Wenchang Ma, Portfolio Manager for Investec Asset Management in Hong Kong.


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