ASI: What’s next for China?

September 20, 2021

This is a commentary by Devan Kaloo, Global Head of Equities, Aberdeen Standard Investments

For the past two months, global investors have been selling China-focused equity funds because of concerns around the Chinese government’s new regulations on the economy, and a surge in the coronavirus Delta variant.

President Xi Jinping has unveiled policies to promote the Communist ideal of shared wealth and ‘common prosperity’. Schooling, housing and healthcare are all to be made more affordable and available. Companies with monopolies, tech companies, private education companies, online insurance companies and luxury property companies are all under scrutiny and, in some cases, new regulation.

Is this the end of capitalism in China? Lately, China has performed poorly against emerging and global markets. The onslaught of regulatory measures coming from the government has created uncertainty and challenged successful business models.

The Chinese government is trying to address inequality and bring about ‘common prosperity’. It is tackling anti-competitive practices, promoting the interests of labour and reinstating the influence of the state in public services. The regulatory measures coming out in the last six months have created a lot of uncertainty for investors with regard to e-commerce companies, education companies, healthcare companies and even the property sector.

Since 1979, China has been the fastest growing economy in history; this has caused sky-rocketing inequality. The government’s focus now is how to better share those gains. This may be the next phase of growth for China. It is not about to give up the success it has enjoyed over past decades.

The private sector remains extremely important and there is a renewed focus on innovation, a key priority for the Chinese government. If it over regulates, it will throttle innovation, if it under regulates, it may create unregulated monopolies.

How to invest in China now

We need to invest on the right side of the regulatory framework and in companies able to adapt. The government is looking to promote innovation, green technology, affordable healthcare, improved livelihoods and domestic consumption.

In the short term, the Chinese domestic economy may feel the impact of financial tightening and a further wave of Delta variant Covid. But we think this will be transitory and we are finding many longer-term opportunities.

China remains a risk, but no more than 5-10 years ago. It is looking to flex its diplomatic muscles and be more assertive. But risk has been priced in and there is much value in some sectors. Currently, the MSCI China A onshore versus the S&P 500 is at a 50% discount price/book and a 35% discount price/earnings. This discount indicates that much of the risk is priced in.

Winners and losers post-regulation

The policy changes have brought winners and losers. On the positive side, the government wants to increase ‘localisation’ and self-reliance. There is focus on domestic consumption and domestic brands. The government is also encouraging the development of homegrown technological leadership in areas like the semiconductor industry. .

There is a green revolution in progress in China, a strong commitment to net zero, so an overhaul of the utilities sector is underway.

Property will see headwinds as the government has identified affordable housing as a priority. What’s likely is that companies will adapt to the new regulations.

Two areas where we see potential negative effects are healthcare and education. Healthcare is to be made affordable and basic healthcare is to be available for all. However, there will still be a push in research and development, so this is where we see interesting opportunities.

In education, it appears that the government is uncomfortable with private sector involvement. As a result, companies offering services such as private tuition have suffered.

On common prosperity

If you take the drive for common prosperity not as a move against billionaires, but rather as a drive for more people to have more income, to develop local brands and have companies that can represent China internationally, then it becomes more positive. Education, housing and healthcare are what people care about, so the measures taken will be very popular. Yes, we probably will see more regulations, but the government doesn’t want to stop growth or innovation, so that will act as a balance.

On monopolies

If companies are charging high prices because they have a monopoly, that’s not going to be acceptable. But if customers have other options, and they are choosing to pay high prices for perceived quality, then that will be allowed.

China and ESG

You can now have a conversation with every Chinese company about ESG and you can talk to the regulators about this too. It’s very different to 10 years ago. But ESG awareness in China is lower than in other countries and it’s up to us as investors to help educate and drive this area. Chinese companies are often rated poorly not because there’s no interest in ESG, but because companies don’t disclose this information.

Chinese firms ADR delisting

Chinese firms may delist from US stock exchanges if no compromise is reached. It’s possible that the bulk of companies will move to listing in Hong Kong or China. We prefer Hong Kong listing to US listing as there is better protection for minority investors.

A buying opportunity?

We see the opportunity to add some domestic names. For most foreign investors, the big interest is the e-commerce sector. We’d be shy of adding right now, but these companies are great value and we expect them to do well longer term, as they still have a role to play in China’s development.

Currently, the MSCI China A onshore versus the S&P 500 is at a 50% discount price/book and a 35% discount price/earnings. This discount indicates that much of the risk is priced in.

China is currently leading the way. It was the first country to have Covid and the first country to recover.  Growth is currently slowing again and the economic cycle is turning down for larger companies. We think China will start easing again and we will see economic recovery. Meanwhile, other economies may slow again, while in China we could see a change in direction from slowing to acceleration.