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Sizing up Chinese equities – a market too big to ignore

Sizing up Chinese equities – a market too big to ignore

31-08-2020 | Insight

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.

  • Jie Lu
    Head of Investments China

Speed read

  • China's mainland stock market is the second-largest in the world
  • Lots of opportunities in companies as coronavirus scare abates
  • Country is on a clear recover path as one of the few offering growth

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.

Investors can not ignore China anymore: second largest market in the world

Source: MSCI, Robeco

Victoria Mio, Portfolio Manager for Robeco’s China A-shares and H-shares strategies, says the vast market is still largely undiscovered and under-utilized by Western investors, which she believes 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,” she 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 less 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.”

Levels of inclusion of Chinese A-shares in the MSCI EM Index

Source: MSCI

Emerging from lockdown

Mio 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,” she 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 healthcare 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 merge with to survive.”

“And don’t forget the companies such as consumer staples which were not affected at all. It’s only really the companies in the discretionary consumer space involved in tourism, restaurants, retailers, and so forth that got hit. They are facing an L-shaped recovery, and so have we reduced our exposure to them.”

Four pillars for reform

Mio 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 consumption upgrade as Chinese citizens become richer; technology and innovation that is driving progress; structural reforms including a bigger focus on the environment; and industrial upgrade including clean vehicles.

“We’re growth investors at reasonable values focused on these four arenas for thematic growth stocks,” she 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.”

Source: Chinese government, Robeco.

It’s all about active investing

Meanwhile, there is no point in being a passive investor in Chinese equities, she says. Rather than acting as a drawback, the market’s notorious inefficiency makes it compelling for active investors like Robeco.

“We have a very, very big deviation from the index, so we are very much an active investor,” she says. “The Chinese equity market is very inefficient, which means there is a lot of investment opportunity potential for an active manager such as Robeco.”

“An inefficient market is the best market for stock selectors to show their ability. If you invest passively, I believe you would miss out on a lot of opportunities.”

Growth engine is revving again

Finally, investors should look to China resuming its status as the engine of world growth, she 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,” Mio says. “There was also another outbreak here in Hong Kong, which meant we all had to go back to working from home again.”

“We think there may be a third or fourth wave in selected cities, but given past success, we believe 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.”

Hong Kong sentiment

She says the potentially bigger issue is the new security law that Beijing is imposing on Hong Kong, threatening the former British colony’s quasi-independent status. “What investors really care about is whether this will impact the stocks,” she says.

“Many companies that are registered in Hong Kong are actually running the operation in China, so it’s not that problematic as such. We believe Chinese equities will continue to do well, though Hong Kong local companies may get hit from a sentiment perspective.”

“When the investor does have this sentiment issue, then it will affect the H-shares rather than the A-shares. We see that H-shares underperform A-shares to some extent, because of this uncertainty.”

No new bubble

Meanwhile, the stimulus planned by China should not create a new bubble, Mio 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 likely add to the credit bubble, and we don’t think there will be a major setback.”

“We firmly believe that 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. We believe this translates into investors being able to get much more certainty, visibility and stability for their money.”

Investing in Chinese Equities

Robeco offers two main means of investing in Chinese equities. The Robeco Chinese Equities strategy (since May 2007), which invests in both H- and A-share companies. And the Robeco Chinese A-shares strategy, which began in 2017 and targets companies listed on the Shanghai and Shenzen stock markets. The exposure of this portfolio is 100% A-shares. Both are managed by Victoria Mio, a veteran portfolio manager who has been with Robeco for 14 years, and advised by Jie Lu, the Head of Research for China.
Robeco Chinese Equities & Robeco Chinese A-share Equities: Expert access to a wealth of investment opportunities in China’s transforming economy
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