The China Decade An Investment Opportunity November 2020 - Binary Capital
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The China Decade
An Investment Opportunity
November 2020
Long-termism shapes our relationships and our investments
The China Decade
Co-authored by:
Summary
China is an opportunity for growth. It is our opinion that global
multi-asset allocators can benefit from dedicated exposure to
Chinese equities, and a mindful allocation to China A-shares in
their liquid investment portfolios. The following note outlines
that a forward-looking perspective and a patient long term
time horizon is essential when developing an investment
strategy for Chinese equities.
Amir Miah Our investment case for China is focused on:
Junior Portfolio Manager
• The domestic story
• Availability of exceptional companies
• Diversification and being ahead of the curve
Introduction
China is the world’s second largest economy, or the largest by
purchasing power parity. It made up over 17% of global GDP in
Nicholas Todd 20191 and contributed around 42% to global GDP growth over the
Investment Analyst past decade - over 1.5x the growth of all G7 countries combined.
It is hard to believe that China and Hong Kong make up only
around 5% of the MSCI All country world index, an index used by
so many practitioners for passive investment exposure or
investment policy benchmarks.2
Both active and passive global asset allocators, particularly those
based in the UK, currently gain exposure to China through Global
Emerging Markets or Asia excluding Japan mandates. By
allocating in this way, one can argue that many UK allocators are
underweight Chinese equities and may have less control on what
Sam Boughton the Chinese equity allocation of their portfolio looks like – in
Investment Analyst terms of individual stock holdings, percentage of portfolio
weighted in China and their allocation to onshore Chinese
equities.
This note focuses on a selection of arguments for and against a
dedicated allocation to Chinese equities. We discuss China as a
distinct asset class to Emerging Markets and Asian equities and
some considerations when constructing portfolios with the
inclusion of a China specific mandate.
The China Decade 1
The perils of investing in China
We start by identifying some of the The recent restrictions on companies such
drawbacks associated with investing in as TikTok and WeChat, and the negative
China – where historically, secondary press around the concerns of Huawei being
markets can be said to resemble a casino a security threat, certainly cloud investors
with regards to the risks to investors capital judgement and may dampen Chinese
and the daily volatility of prices: will I get my companies’ hopes of international
money back? expansion. What will be result of this
ongoing trade war: is my capital safe in
For the readers reference, we can show this China?
market volatility through Figure 1 and 2 on
the following page. The charts illustrate the Furthermore, there are issues of rising
price movements (USD) since 2013 of the household debt levels which has the
CSI 300 Index and MCHI an iShares ETF that potential to impact future economic growth.
tracks the MSCI China Index. We can see China’s household leverage has surpassed
periods of significant sharp short-term the EUs at 50% of GDP but has remained
growth, particularly evident from June 2014 relatively low at about 54% of GDP when
to June 2015. Here, the Shanghai and compared to 75% in the US. The rising
Shenzhen indices increased by over 110% repayments may have an impact specifically
and 175% respectively. Oliver Blanchard, the on consumption driven growth in the long
then Chief economist at the IMF, said in July term. What is important to note is
2015, this was “obviously a stock market household incomes have continued to rise
bubble.” In the month after, a sharp sell-off and will likely suppress the impact of said
followed with both exchanges each declining debt levels. Will China really become a
by around 45%. nation of consumers?
Much of the inefficiencies in China’s financial Finally, from an environmental, social &
markets, particularly with regards to China governance perspective, data from Chinese
A-shares (onshore equities), can be companies has historically been inaccessible
attributed to the make-up of the market and of poor-quality. More serious ethical
participants, with retail investors investors may want to sit this one out until
contributing to around 80% of total market there is tangible improvements on all
volumes. The short-termism of most retail aspects of ESG and transparency of such
traders leads to heightened market volatility improvements. Extensive resources are
as investors chase extreme asymmetric required for enhanced due diligence on
returns, often, akin to gambling. listed equities. In addition to ESG concerns,
we must be aware of the fraud cases that
Geopolitically, what effects will the US have been unmasked and associated with
election have on US-China trade tensions, the use of shell companies and a boom in
and will they overshadow Chinas ability to reverse mergers at the start of the last
expand on the international stage? decade. This was captured well in the 2017
Netflix documentary, ‘The China Hustle’.3 We
need to seriously consider this – trust and
integrity is central to our investment
“obviously a stock process. Corporate governance in China has
market bubble” been improving but much more needs to be
done.
Oliver Blanchard,
Chief Economist, IMF 2008-2015
The China Decade 2
Figure 1: CSI 300 price movements since 2013
The following chart shows the price performance of CSI 300 Index in USD since 2013
and highlights the investment bubble in 2015. The CSI 300 is a capitalization-weighted
stock market index designed to replicate the performance of the top 300 A-Share
stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
Figure 2: MCHI US price movements since 2013
The chart below shows the price performance of MCHI an iShares ETF that tracks the
MSCI China Index in USD and highlights the significant drawdowns in 2015 and 2018.
The MSCI China Index captures large and mid capitalisation representation across
China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs).
The China Decade 3Building a case for a dedicated exposure to
Chinese equities
At Binary Capital, we believe the past is the
past, we want to focus on being forward
looking. We see a significant investment
opportunity in China. Here we summarise
3 key reasons why a global multi-asset
allocator may be interested in allocating to
a dedicated exposure in China. These are
as follows:
a. The domestic
story
b. Exceptional
companies
“Let China sleep; for when
she wakes, she will shake
the world.”
Napoleon Bonaparte
c. Diversification,
and being
ahead of the
curve The China Decade 4a. The Domestic Story
Growth!
Figure 3: Annual GDP growth Rates, 2000 – 20194
Over the course of two decades, China has
had an average GDP growth rate of over 9%
when compared to a global average of 3%.
As a result of COVID-19, we have had to
adapt the way we live, and no country so far
has been able to do this as well as China.
Collectively, the population has been able to
maintain a close to zero level of infections
over the past couple of months which has
transferred into mainly positive economic
data. According to the latest IMF estimates,
China is set to be the only major economy to
see growth in 2020 growing 1% real GDP
annual change and 8% in 2021.
Moreover, China is becoming less reliant on
Figure 4: China’s urban & rural population as a percent
exports as a percentage of GDP growth,
of total population, 1960 – 20165
which has fallen consistently from 36% in
2006 to under 19% in 2018. The developing
high-tech and service sectors, and the
increase in annual household incomes of 9%
between 2011 and 2017. The persistence of
such trends, will see the emergence of a
more balanced economy: domestic demand
and export led.
Demographics
China makes up nearly 20% of total global
human population, with 1.4 billion people -
that is 1.8x all G7 nations combined. The Urban Population % Rural Population %
demographics in China are continually
evolving, an ever-growing population,
increased urbanisation, a well-educated
labour force, and a growing middle class
with increasing levels of wealth that are Figure 5:Pearl River Delta Greater Bay Area, 20186
driving a growing contribution to total global
consumption growth.
The Chinese Government continues to
encourage labour mobility not only into
megacities such as Guangzhou and
Shenzhen, but also Tier 3 to Tier 6
‘megaregions’ which are expected to create
a 1 billion ‘high-quality’ urban population by
2030. Infrastructure projects such as
facilitating the inter-regional settlement of
people to the Greater Bay Area to create a
Silicon Valley–style technology and
innovation hub are aimed at boosting the
Chinese economy’s value adding capabilities.
These are central to the China growth story.8 The China Decade 5Policy
A major initiative in China under Xi Jinping is the Made in China 2025 strategy.9 The
strategy targets domestic growth opportunities and a significant push towards advancing
ambitions to become a knowledge-based economy, whilst concurrently reducing reliance
on foreign technology imports – semiconductor chips from the US as an example.
Many of the technologies that Chinese policies are targeting, fit the narrative of the “4th
industrial revolution” – the rise of Artificial Intelligence for example. There is a focus on
automating traditional manufacturing and industrial practices using modern, smart,
difficult to replicate technology, resulting in increased output of essential components and
‘high quality’ final products. It is expected that such motivated, long term policy will
facilitate China’s ambitions to become the World’s primary innovation centre by 2030.
The rebalancing of the Chinese economy has been underway since the mid-90s. We have
seen eight consecutive years where consumer and services contribution to GDP was
greater than manufacturing and construction and where the percentage of the workforce
in the services sector has increased from 34% to 47% whilst those in the industrials and
agriculture sectors have fallen from 66% to 53%.9
Made in China 2025 – 10 Key Sectors
Aerospace High-end computerized
machines and robots
Advanced railway Maritime equipment
transportation and high-tech ships
equipment
Agricultural New generation
machines information technology
Biopharma and New energy and energy-
high-tech medical saving vehicles
devices
Energy equipment New materials
The China Decade 6b. Exceptional companies
To gain exposure to Chinese equities there is an Figure 6: Number of Equities in China10
‘alphabetical soup’ of share options that one
must consider. Traditionally, foreign investors
would gain exposure through American 2500
Depository Receipts (ADR’s) – available to buy on 2239
US exchanges. However, for many key sectors, to
gain exposure to the domestic story we must 2000
look at A-Shares. There are over 5,000 Chinese
and Hong Kong stocks with a market cap greater 1521
1500
than USD $50 million, making up around 20% of
total global market capitalisation. The Shanghai
and Shenzhen equity markets make up the
1000
largest proportion of this – at circa. 90%.
Mega-cap companies such as Tencent, Alibaba 500
and PingAn are extraordinary. Companies which 261 233
are taking full advantage of the China/global
growth story and structural shifts taking place in 0
the region, providing the services that people China A - China A - US ADRs China H -
now rely on daily - the giants of the eastern Shanghai Shenzhen Hong Kong
market. A dedicated China exposure allows us to Type of Chinese Equity
increase conviction in the mega-cap giants and
gain diversified exposure to quality onshore
domestic companies on the tail-end.
If we take Ant Group for example, currently a private company we have gained exposure to
within our Investment Trust portfolios (exposure through Scottish Mortgage Investment
Trust). They are targeting a valuation of over $300bn through a dual listing in Hong-Kong
and Shanghai as a result of exponential growth and dominance of Alipay over the course of
the past decade. It is used by more than 700m people and 80m businesses to make mobile
payments, invest in mutual funds, buy insurance, and pay bills monthly - a true domestic
China growth story.
There are winners in China, winners in all sectors and industries that make up the Chinese
economy. These winners will continue to target the ‘new’ Chinese economy and will create
much value in general and for investors. Table 1 on the following page includes examples of
some exceptional companies.
In China, red represents
wealth, fame, and prosperity.
The China Decade 7 7Table 1: Example of Chinese growth stories11
Market
Chinese Similar
Cap
Company Brief Description Company
(USD)
Communication Services
NetEase NetEase is the second largest online gaming provider
behind Tencent - 79% of its revenue comes from this • Riot Games
$60bln
business. It also provides music streaming, livestreaming • EA
and e-commerce products.
Tencent Tencent is an internet-based platform company using
technology to enrich and improve the Chinese technology
ecosystem. It has many pillars of product segment which
allow Tencent to ‘connect everything’. Its main $747bln • Facebook
communications network WeChat is used by 1.2 billion
people worldwide. It also provides utility software such as
QQ mail and QQ browser for every necessity.
Consumer Discretionary
Alibaba Alibaba is a holding company that provides technology
• Amazon
infrastructure and a fundamental marketing platform. It
$844bln • Google
allows worldwide merchants and brands to develop new
technology within the Chinese network. • Ebay
Meituan
Dianping Meituan, formerly Meituan Dianping, is a China-based
e-commerce platform providing life services. The company
$225bln • Uber
provide services satisfying people's daily eating needs
through its food delivery brand Meituan.
Midea Midea specialises in consumer durables, more specifically
air treatment, refrigeration, laundry, large cooking
$85bln • Johnson
appliances, large and small kitchen appliances, water
appliances, floor care and lighting. Controls
Financials
Ping An
Insurance Ping An of China has grown into a personal financial
services group which provides services of three business
pillars, i.e. insurance, banking and investment. It promotes • Prudential
$204bln
both the traditional finance and Internet finance for over Financial
200 million users. Ping An Insurance is the 4th largest
company in China based on market capitalisation.
Health Care
Kingmed
Diagnostics Kingmed Diagnostics provides medical diagnosis services to
hospitals, maternal and child health centres. Its services
Group $7bln • AstraZenaca
cover 90% of China and relies on its extensive high-quality
R&D.
Source: Bloomberg, Binary Capital, 29 October 2020c. Diversification and being ahead of the curve
Diversification & domestic exposure
A-Shares offer diversification benefits to investors through a low correlation of returns to
other global equities (See Figure 7 below) – although, this may not persist in the future.
There is also a phenomenon where companies trade at either a discount or a premium
depending on the share class issued; with China A shares trading at a discount to H shares
for example.
Domestic listings are on the rise in China, and more and more Chinese entrepreneurs are
looking to list on their home exchanges rather than abroad in the US on the NASDAQ or
NYSE. We believe that many future China winners will be China listed only.
Figure 7: 3-year correlations of asset classes12
MSCI China CSI 300 EM US UK EU Japan
MSCI China 1
CSI 300 0.75 1
EM 0.89 0.67 1
US 0.49 0.27 0.58 1
UK 0.58 0.36 0.73 0.71 1
EU 0.59 0.36 0.73 0.70 0.93 1
Japan 0.34 0.34 0.43 0.21 0.34 0.32 1
MSCI Inclusion
The MSCI Emerging Markets Index has recently increased allocation of China A-shares from
5% to 20%. This significantly improved representation of China’s onshore, domestic
companies, will lead to increased foreign investor inflows from both passive and active
strategies that use the benchmarks for portfolio construction. As the barriers to entry for
institutional investors diminish it will create a more balanced investor structure in the market,
moving away from retail trader dominated markets. Furthermore, the increased inclusion
should result in improved accountability and transparency in China’s capital markets.
Figure 8: MSCI Emerging Markets Allocation13
MSCI EM Index with 20% China A Shares Inclusion MSCI EM Index with 100% China A Shares Inclusion
Source: MSCI
The China Decade 9Closing remarks
It would be reasonable for a long-term investor with an
investment horizon of over five years to consider a
dedicated allocation to Chinese equities, rather than mix
and match with EM or Asia ex mandates as is common
with investment professionals in the UK. Using a
dedicated exposure provides long-term allocators the
ability to increase conviction in China and more control
on the specifics of allocation to Chinese equities – Do I
want exposure to Greater China, more exposure to the
ADR giants or domestic A shares?
If the idea of China as a standalone asset class catches
on, looking forward, global multi-asset allocators may
begin adopting Emerging Markets ex China and China
specific fund mandates for portfolio construction. We
note in the US you can already buy an Emerging markets
ex China ETF.
There are well established funds that provide exposure
to Chinese equities, available in the UK – both active and
passive. There is a growing number of product providers
that offer China A-share specific funds. Product
availability does not seem to be an issue. The indices are
backward looking with yesterday’s winners. China is
changing and an active long-term approach seems a
sensible option to take advantage of the structural
changes happening in China, now and into the future.
Investing in China as a discretionary fund manager,
takes courage as you move further away from
benchmark thinking and away from the regulatory risk
machines that tell us how to build our ”suitable”
portfolios. It takes independent thinking and real
conviction.
11
The China Decade 110References [1] Data Source: Statista.com: China Share of Global GDP. [2] Data Source: MSCI ACWI Index (USD) Factsheet, September 2020. [3] Netflix Inc: The China Hustle, Documentary, directed by Jed Rothstein, 2017. [4. 5] Data Source: The World Bank [6] China Briefing, Dezan Shira & Associates: What is the Greater Bay Area Plan, 2019. [7] International Monetary Fund: IMF Data, 2020. [8] China Briefing, Dezan Shira & Associates: What is the Greater Bay Area Plan, 2019. [9] Institute for Security and Development Policy, Made in China 2025, 2018. [10] UBS Asset Management, Insights: China 2020. [11, 12] Bloomberg, Binary Capital Investment Management, October 2020. [13] Data Source: MSCI Emerging Markets Index (USD) Factsheet, September 2020. Disclaimer The Information in this document is not intended to influence you in making any investment decisions and should not be considered as advice or a recommendation to invest. Any Information may not be suitable for all investors and investors must make their own investment decisions using their own independent advisors and relevant offering material. Any investment decisions must be based upon an investor's specific financial situation and investment objectives and should be based solely on the information in the relevant offering memorandum. Income from an investment may fluctuate and the price or value of any financial instruments referenced in this document may rise or fall. Past performance is not necessarily indicative of future results. Source of data: Bloomberg, Binary Capital IM. We assume no responsibility or liability for the correctness, accuracy, timeliness or completeness of the Information. We do not accept any responsibility to update the Information. Any views, opinions or assumptions may be subject to change without notice. Binary Capital Investment Management Ltd is incorporated in England under company number 06692644, registered office, 25 Green Street, Mayfair, London, W1K 7AX. Binary Capital is a trading name of Binary Capital Investment Management Ltd. Binary Capital Investment Management Ltd is authorised and regulated by the UK Financial Conduct Authority (reference number 507900). Principal place of business: 25 Green Street, Mayfair, London, W1K 7AX.
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