Despite being the first to fall prey to the Covid-19 pandemic, China has done well dealing with the scourge as it suppressed the contagion relatively swiftly. At the height of the Covid-19 pandemic, it was responsible for nearly all of the world’s economic growth as it grew 2.3% in 2020. But with global recovery underway, will China lose its “first in, first out” advantage?
“In the 10 years through 2019, China, on average, accounted for about one-third of global economic growth, larger than the combined share of global growth from the US, Europe and Japan,” says Matthews Asia investment strategist Andy Rothman. He argues that investors have little direct exposure to this tantalising growth proposition. In an average US investor’s portfolio, China only accounts for 3% of holdings.
Yu Song of BlackRock says that Beijing has pivoted away from maximising short-term growth, focusing instead on more sustainable long-term growth prospects via financial liberalisation, reducing financial risks and improving sustainability among other things. Smaller cities, for instance, says UOB’s Suan Teck Kin, have been discouraged by the central government from building subways, forcing them to pursue more value-added “quality” growth strategies from existing capital.
Not to say that there are no risks in the Chinese market, however. “Covid and the US presidential transition have somewhat overshadowed geopolitics but tensions persist. Trade disputes remain unresolved in the longer term and are a symptom of broader tensions,” notes Stephen Tong, client portfolio manager, Franklin Templeton Investment Solutions. He does not rule out an erosion of China’s lead over global peers as Covid-19 recovery takes hold.
Bonds and FX
In the bond space, there has been long-term interest in Chinese government bonds due to their higher yield and relatively lower risk. But as rising treasury yields improve the attractiveness of developed market (DM) bonds — which are considered less risky — Chinese bonds have begun to lose some of their lustre. South China Morning Post reports that global funds trimmed Chinese government bond holdings by RMB16.5 billion ($3.37 billion) in March 2021 — the first time in two years.
“Month-on-month in March, the China High Yield segment returned –0.75% while average YTW (yield-to-worst) stood at almost 9%, an increase of 1.5 percentage points since the beginning of the year,” says Vasu Menon, executive director, investment strategy at OCBC Wealth Management. Investor confidence has been shaken by tight onshore liquidity, ongoing defaults and profit warnings at several real estate firms, prompting a flight to quality bids.
Yet, Pradeep Kumar, portfolio manager for local rates and FX at PGIM Fixed Income, continues to see value in the Chinese bond market. “We view the Chinese local bond market as a core holding over the medium-to-long term for a local emerging market portfolio. Its bond yields are attractive relative to G3, and compared to other EM rates markets, China offers diversification benefits as the market drivers tend to be more self-contained,” he tells The Edge Singapore.
Menon believes the current volatility is a good buying opportunity for quality Chinese bonds. But he warns that greater credit differentiation when doing bond selection and good stamina to ride out the volatility are needed to profit from the Chinese bond market. UOB’s Suan, meanwhile, believes that green bonds could be a way for investors to buy into the infrastructure spending needed to bring China to its goal of carbon neutrality by 2060.
Song of BlackRock is positive on the strength of the RMB given a strong growth forecast in China in the coming year as well as resilient FDI and export figures. Kumar of PGIM attributes the RMB’s strength in 2H2020 to the PBOC’s lack of monetary easing, increasing rate differentials between RMB and USD to a five-year high as the Fed turned on the taps.
“We have seen manifold appreciation of the RMB although the government has taken action since the second half of last year to prevent that from happening,” Song tells The Edge Singapore. Beijing has made it easier for local investors to invest overseas, made foreign borrowing more difficult and encouraged local businesses to hold cash in US dollars rather than RMB.
“For people who are worried about ... currency depreciation, they should know that there is a cushion,” Song explains. Should any downward pressures be exerted upon the RMB, Chinese policymakers have the option of unwinding some of the measures it took to check currency appreciation, helping to maintain currency stability, he adds.
A E I O U
For equities, Tong of Franklin Templeton believes that dual circulation related stocks such as domestic consumption and technology will benefit from greater policy support. In particular, says global economist Paul Hsiao of PineBridge, high tech sectors such as artificial intelligence, 5G infrastructure and big data are seen to perform strongly, especially with deeper integration with traditional sectors.
Caroline Loke, portfolio manager, Asia ex-Japan equities at Pinebridge Investments, prefers to analyse the Chinese economy in terms of megatrends rather than sectors. Her preferred megatrends are the “vowels of the English language” — A, E, I, O and U. “A stands for automation, E stands for energy and environment, I is for information technology, O stands for outsourcing and U stands for urbanisation — all focus areas of 14FYP,” she explains.
Better yet, says Catherine Yeung, investment director at Fidelity International, most Chinese innovation thematic plays have lower penetration and thus a longer runway than their US counterparts. Software expenditure as a percentage of GDP in the US is six to seven times that of China. Additionally, Chinese tech companies — especially A-shares — are trading as a discount to US counterparts, with Alibaba trading at a 58% discount to Amazon and Weimob at a 64% discount to Shopify.
“In China, we continue to stay with industry leaders for their long-term ability to maintain growth. These are firms leading in innovation, brands, and platform ecosystems, for which investors are prepared to pay premium valuations,” Hou Wey Fook, chief investment officer, DBS Bank, notes in DBS’s 2Q2021 CIO Insights Report.
Suan sees value in Chinese consumer products as well. The country’s large consumer market is not to be taken lightly as Beijing strengthens “internal circulation”. Eli Lee of BOS is also keen on onshore sourcing, import substitution and new infrastructure themes. Gary Dugan, CEO of The Global CIO Office, sees major investments needed in pharmaceuticals and health tech sectors amid a major upgrading of China’s healthcare sector.
With much of China’s generous R&D funding going into SOEs, investors may wish to be exposed to the state-led innovation ecosystem. “China’s SOEs account for near 40% of its stock market and more than a third of its public investment,” says Ori Ben-Akiva, director of portfolio management at Man Numeric, and senior portfolio managers Mickael Nouvellon and Ziang Feng in January 2019.
The Man Numeric team notes that firms with greater government ownership outperformed the broader Chinese A-shares market in 2018. They attribute this to less exposure to government deleveraging campaigns and weaker sensitivity to credit risk due to “higher-quality bonds, lower borrowing costs and less reliance on shadow banking”. In January 2019, the total operating profits of the top 60 non-bank SOEs were up 17% since 2016 according to Bloomberg.
“China remains underpinned by strong economic growth, as well its first-in, first-out status as the major economy in the world to return to pre-Covid normalcy. Mutual fund investors globally are underweight China, so there remains a lot of opportunities to the upside in the longer term for equity markets,” comments Yeung of Fidelity.
SGX plays that investors can consider for China exposure include China Aviation Oil, an undervalued play that stands to benefit from a recovery in travel and oil prices. DBS Research projects the counter to enjoy more than 20% upside to its target price. UOB Kay Hian’s Adrian Loh identifies Sasseur REIT as a pure-play on Covid-19 recovery and a stronger RMB, with the REIT’s four outlet malls seen to benefit from a recovery in domestic consumption.
China Everbright Water — a water environmental management firm — provides exposure to China’s ESG drive. For the year ended Dec 31, 2020, it secured RMB1.19 billion worth of new projects, adding to its total of RMB24.68 billion on hand as at Dec 31, 2020. For FY2020, it recorded earnings of just over HK$1 billion ($171.6 million), up 23% y-o-y.
At this level, China Everbright Water’s Singapore quoted shares are trading at just 4.13 times historical earnings, giving a dividend yield of 6.71%.
