Comment from Rob Morgan, the Pension and Investments Analyst at Charles Stanley Direct:
As the second largest economy in the world, and one of the fastest growing, investors should keep a close eye on China. However, is it possible to know what is really going on? Certainly some are wary of official figures, though the prevailing trends are clear to see. We know that exports have been fading for some time as a proportion of economic activity, increasingly replaced by investment in buildings and infrastructure as well as consumer spending. However, this economic shift, whilst exciting, is also causing concern. Notably, many commentators predict a property bubble will ultimately burst leaving the banking sector with losses. There are concerns too that Chinese authorities are spending more and more on infrastructure for progressively less return.
It is impossible to predict the outcome, but these changes mean growth in China is likely to slow, possibly quite rapidly. According to Devan Kaloo, head of Emerging Markets at Aberdeen Asset Management, this should not be seen as disaster for Chinese equities. As he points out, stock market returns are often not usually correlated to GDP growth. Indeed, China has already shown this. Growth over the past couple of years has held up relatively well yet returns from the Chinese market have been dismal. More important are developments at a corporate level, and in recent years economic growth simply hasn't translated into increasing profits for Chinese firms. Indeed, as Mr Kaloo explains, an economic slowdown in China may not be a bad thing. While it might cause short term pain it could also force companies to more strictly control costs, slow down their spending and concentrate on increasing profitability, setting the stage for better long term returns.
It is clear the Aberdeen Asian and Emerging Markets teams are sceptical of stocks available on the mainland Chinese market. The Aberdeen Global Chinese Equity Fund has a mere 8% invested here. The remainder is in Hong Kong-listed firms plus some UK and Singaporean companies with significant exposure to the region. As Nicholas Yeo, Head of Chinese equities at Aberdeen points out, the emphasis of their process is on finding good-quality companies at low prices; and in China there are a number of hurdles to finding them. Government interference is widespread, particularly in the banking sector, and they uncover few mainland-listed companies that provide sufficient disclosure and are focused on returns for shareholders. In contrast, in Hong Kong they find corporate governance is much stronger.
So is it worth considering Chinese equity exposure right now? Certainly there could be an opportunity emerging in terms of valuations. On metrics such as price-to-earnings and price-to-book share, prices are not far off 2008 levels when markets everywhere fell amidst the global financial crisis. However, there are differences across the sectors. The Aberdeen Global Chinese Equity Fund is biased towards consumer-orientated firms, which are typically more expensive. However, they are less likely to be influenced by the hand of government. Recent market volatility has also given the Aberdeen team the chance to top up favoured holdings such as industrial gases supplier Yingde.
Like all emerging markets China will continue to experience growing pains. The key risk is Chinese authorities being unable to keep a lid on credit growth and losing the ability to control the economy. The extent of the "tapering" of quantitative easing in the US will also have an impact on sentiment. However, I believe it is worth owning a small amount of exposure. In my view the Aberdeen Global Chinese Equity fund, with a concentrated, high conviction portfolio, and a stringent due diligence process that I believe should enable it to continue to navigate this complex market well, is worthy of consideration.
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