Winners and Losers
A quick scan of some of the larger foreign institutional investors who hold investments in China (a very small number, by the way!) suggests that many are accessing the China market via exposure to a local index fund or ETF (providing access to say the top 10 companies only) or by making a one way bet on a single large tech company (e.g Alibaba, Baidu and Tencent, which are also listed in the US).
This is a mistake for at least 3 reasons:
- A major shift in China’s recent policy priorities is a move towards ‘common prosperity’ (i.e. social equality, national security and self-sufficiency) by narrowing the disparities between the rich and poor and introducing new measures designed to level the playing field (e.g. regulatory intervention, taxation, welfare and greater emphasis on charity, donations and volunteering - a new concept for China). As a result, many of the big companies that have enjoyed success over the past decade are likely to have their wings clipped in the years ahead. Investors are likely to achieve stronger gains by investing in some of the lesser known companies with lower profiles but greater prospects in the fast growing domestic economy.
- Chinese regulators were flagging their intention to introduce greater supervision of overseas listed Chinese companies for some time, but the decision by DIDI to proceed with its US listing in 2021, before completing a national security review, was a catalyst for the introduction of major reforms (e.g. Anti-Trust Law targeting big e-commerce platforms and Cybersecurity Law targeting big data companies). Whilst it’s unlikely that China’s ultimate goal is to prevent companies from listing overseas, the combination of US-China tensions and the new measures described above are creating major headwinds for some of the larger dual listed companies.
- Like many emerging markets, China’s A share market could be described as ‘inefficient’. According to Economic Theory “inefficient markets exist when asset prices don’t accurately reflect their fair or true value. This can occur when investors are interpreting information differently, don’t have access to the same information, or aren’t being completely logical. In some instances, they may be buying and selling based on their emotions, all of which can cause assets to become under or overvalued”. Local Chinese Fund Managers (who are based in China, have their ear to the ground and are experienced in valuing Chinese listed companies) are able to exploit some of these inefficiencies by identifying local shares that offer good value, strong management and excellent prospects. It's not impossible but it’s very hard to pick these winners from a distance.
It's time for a new approach to investing in China. Investors who are passively investing by benchmarking MSCI China (with 8 out of the top 10 holdings being BIG Internet companies) will find it tough going in the Year of the Tiger and beyond.