Investing in China is a question of stock picking rather than index picking

Investing in China is a question of stock picking rather than index picking

08-01-2020 | Interview

In just a decade, Chinese assets have gone from exotic category status to that of must for global investors. This calls for a much better understanding.

  • Yann Morell Y Alcover
    Morell Y Alcover
    Investment Writer

Speed read

  • The relationship between China and the West has changed radically
  • China faces many challenges and may not overtake the US by 2030
  • Finding expert managers is key for investors to make the right choices

george-magnus-thumb.jpgWhat is the China-US ‘trade war’ really about? Will China inevitably overtake the US as the dominant power? How should investors approach Chinese equity markets? Here are some of the questions we discussed with George Magnus, former chief economist at UBS and author of Red Flags: why Xi Jinping’s China is in Jeopardy, published by Yale University Press in 2018.

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Over the past couple of years, global financial markets have been swinging to the tune of US-China trade dispute. What’s your take on the nature of this confrontation?

“This conflict is obviously about trade because we know that the high-profile part of the coverage is about tariffs. But since 2018, we have learned that what's really going on is a reset of the US-China relationship, in which trade is an important part but only the tip of the iceberg.”

“A number of other topics have been drawn into this dispute between not just China and the US, but also China and the EU as well, although things remain a little quieter as far as the EU is concerned. These topics include aspects that are closely related to trade, like foreign direct investment, but also other things, like the activities of technology companies, in particular telecommunications.”

“It also involves many issues which Western companies complain about in China, like weak intellectual property protection, ownership limits on companies, access to markets and subsidies, or preferential treatment in procurement and the application of standards. All these elements speak to a much more existential conflict between China and the West.”

Then what is the most likely outcome? If this is really about the existence or the dominance of each block, a trade deal may not put an end to the dispute…

“Yes. This is about the struggle for supremacy, or at least the struggle for dominance. And it has become more sensitive because, although it's not formally part of the US government's agenda, some members of the administration talk a lot about a so-called decoupling. Meanwhile, the Chinese are not innocent bystanders.”

“Every time you hear Americans talk about decoupling, you can hear Chinese nationalists talk about self-reliance. So, the relationship between China and the West will not be like it used to be going forward. It'll be more competitive, perhaps a little bit more edgy and there are certain things which we will never agree on. But I don't really want to believe that this is not a relationship that can be managed if there's goodwill on both sides.”

The idea that China will rule the economic world in a few years’ time, I think, is definitely not proven

Many people say China will soon become the kind of superpower it aspires to and overtake the US. What do you think?

“Well, there are two ways of thinking about this. On one hand, people argue that, given present trends, China will become the biggest economy in the world by, say, 2030. But for this to happen, you need two things: China must carry on growing at a similar pace as it is now, and it must not experience any material depreciation in its exchange rate. Both premises are far from self-evident.”

“On the other hand, the second way of looking at this issue is to think about whether you can take the past and extrapolate it into the future. I mean, we know that there are certain things that China has done very successfully in the past but cannot do again in the future.”

“So, I don't doubt that China will be a growing economy in the future. I don't doubt that it will have business opportunities that people will find attractive. But the idea that China will rule the economic world in a few years’ time, I think, is definitely not proven.”

Still, following a number of market reforms, some of the main index providers decided to include Chinese assets with a local listing in their flagship indices. In 2019, we have seen a noticeable increase in the weight of Chinese assets in these indices and further inclusion is likely. At the same time, MSCI recently warned that it would not include more Chinese stocks until concerns over access to hedging and derivatives instruments and other issues are addressed. What is your view on this?

“From a foreign investor’s point of view, there are certainly good reasons to put money to work in China. Think about some the often-cited investment themes, like the country’s rising middle class, for example. But as the recent MSCI warning suggested, there should be no let-up in the transparency and openness of Chinese companies, when it comes to things like ownership caps in particular sectors, or the opening up of markets to foreign competitors in sectors where they were not allowed equal treatment compared to domestic firms.”

Investors will have to be pretty reliant on their financial services provider or their asset management company to make good choices

We've been quite critical about China, so far. Still, there are positive aspects for investors. Which would you highlight?

“What investors primarily want is interesting ideas that will make the value of their assets go up. The issue for investors will be to find the companies that are going to perform in this environment and that may be able to perform regardless of the macroeconomic context. And for that, they will have to be pretty reliant on their financial services provider or their asset management company to make good choices.”

“We've proven time and time again that in emerging markets – whether it's in Argentina, Brazil or Turkey, you name it – even though investors sometimes go through bad periods, they can still generate very decent returns on a 10 to 15-year horizon. But it is really a question of stock picking rather than index picking.”

This is an excerpt of a longer interview.

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