For equity investors, 2021 was a year of split fortunes in China. The MSCI China index, which has more than 40% of its components in internet stocks, declined nearly 22%, while investors who held stocks on the Shanghai and Shenzhen exchanges had a strong year.
Among the factors driving this divergence were new regulations from the Chinese government targeting the digital economy and "Three Mountains" of high costs — education, health care and property — which left some second-guessing their investments in the world's second-largest economy.
For anyone questioning if China is still investible as the government moves to balance social goals with economic growth, it is important to remember that despite its size, China remains an emerging economy that is continuously evolving. And if history is any guide, investing in China amid rising uncertainty could prove rewarding, as demonstrated by the performance of equities following the country's anti-corruption campaign in 2014, its trading suspension scandal in 2015-2016, and the China-U.S. trade war in 2019.
However, given recent developments, the sectors that captured investor attention and assets in those past periods are unlikely to be the same as those well positioned for future growth. Generally, in China, things change rapidly and hence, future growth is unlikely to be the same growth sectors that have already hit their full potential. Instead, portfolios that tilt toward onshore and midcap Chinese equities will likely reward investors.
Generally speaking, offshore China indexes tend to be dominated by one or two sectors, such as internet stocks, while onshore indexes are more diversified thanks to the size of the markets. For example, the market capitalization for onshore China indexes is more than $10 trillion and spread over more than 4,000 companies. Conversely, the market cap for offshore China indexes is $2.5 trillion that's spread over about 1,000 investible companies.