China’s rise to become the world’s second-largest economy has been matched by the growth of its mainland stock market. And yet despite its size, it remains an undiscovered country for many investors.
It may come as a surprise to some, but the Chinese A-shares market of domestic companies outside of Hong Kong is the second-largest stock market in the world, with a capitalization approaching USD 10 trillion. The independent Hong Kong H-shares market is the fourth largest.
Yet, Chinese A-shares are largely shunned by investors – often for reasons of perception. As China now emerges more quickly from the Covid-19 slowdowns than other nations, and remains one of the few countries showing economic growth, the tide may be turning for investor interest in mainland stocks.
Jie Lu, Head of Investments China, says the vast market is still largely undiscovered and under-utilized by Western investors, when it offers a wealth of opportunities for the growth investor.
“The main problem is A-shares were not included in the MSCI Emerging Markets index until 2018, and then only at a small weighting, so in the past it just wasn’t on the map for the global investor,” he says. “Now it has become too big to ignore.”
“The weighting in the MSCI EM has now risen from 5% to 20%; full inclusion would really put Chinese equities on the global map. But there are some hurdles that the Chinese regulator needs to address before any increase in inclusion is possible, particularly in making the market more opaque.”
“There are still issues regarding disclosure and transparency, and the international investor is not so familiar with the market because of that. We expect these issues to be addressed over the next five years.”
Jie Lu says that while the coronavirus crisis has hit the country hard, many companies have actually benefitted from the lockdowns. “Three sets of companies have done well from this,” he says. “First there are the e-commerce companies, online retailers and those providing internet-based entertainment that have benefitted from the move to online during the shutdowns. They are still doing well.”
“Then there are companies in sectors such health care that have done exceptionally well because of Covid-19. And then there's the third group of companies that will benefit from the stimulus to combat the slowdown, such as the infrastructure plays in industrials, construction materials and logistics.”
“So, there are a lot of stocks that you can choose from. For the companies that haven’t done so well, there is a consolidator in each sector engaged in industry consolidation during the hard times. Maybe the smaller ones may get bought, or they may need to find someone to do merge with it to survive.”
Jie Lu says there is much to be gained from the four pillars of Chinese plans to transform itself into a 21st century society with living standards on a par with the west. These are the consumption upgrade as Chinese citizens become richer; the technology and innovation that is driving progress; the structural reform including a bigger focus on the environment; and an industrial upgrade including clean vehicles.
“We’re growth investors at reasonable values focused on these four arenas for thematic growth stocks,” he says. “Because of Covid-19, China initiated a new round of infrastructure investment, with a focus on the technology side.”
“There are plans to invest heavily in AI, big data centers, ultra-high-voltage facilities, and many other things. Covid-19 has accelerated development in technology and industrial transformation.”
Meanwhile, there is no point in being a passive investor in Chinese equities, he says. Rather than acting as a drawback, the market’s notorious inefficiency makes it a paradise for active investors like Robeco.
“We have a very, very big deviation from the index, so we are very much an active investor,” he says. “The Chinese equity market is very inefficient, which means there are a lot of investment opportunities for an active manager such as us to exploit.”
“An inefficient market is the best market for a stock selector to show their ability to pick the winners. If you invest passively, you would miss out a lot of opportunities; it would make no sense.”
Finally, investors should look to China resuming its status as the engine of world growth, he says. GDP rose by 5.9% in the fourth quarter of 2019 before the outbreak began, but fell by 6.8% in the first quarter of 2020 when China’s vast industrial powerhouse was shut down. Growth of 3.2% was recorded in the second quarter as things began to get back to normal.
“There was a second coronavirus wave in Beijing in June, but it was brought under control within two weeks, thanks to a very efficient tracking system and a lot of testing that was done,” Jie Lu says.
“We think there may be a third or fourth wave in selected cities, but they will be brought under control pretty quickly. So we expect more isolated local situations, rather than another nationwide lockdown. Investors do not need to worry too much about that.”
Meanwhile, the stimulus planned by China should not create a new bubble, Jie Lu says. “This time, the central bank printing more money on the monetary policy side has been more restrained – the stimulus is more on the fiscal side. This means it won’t add to the credit bubble, and we don’t think there will be a major setback.”
“China is still the only one country that can register positive growth this year. And now it’s on a clear recovery path for a V-shaped recovery. Investors can now get much more certainty, visibility and stability for their money.”