China tech pullback provides opportunities

The anti-monopoly strictures Beijing has imposed this year on China's e-commerce giants looks set to unleash a new spasm of competition — a potential gift for the growing ranks of institutional investors looking now to boost their exposure to the fast-growing mainland market.

In the wake of stricter regulatory guidance and fines for anti-competitive behavior, including a record $2.8 billion levied in April on Hangzhou-based Alibaba Group Holding Ltd., executives of the country's top e-commerce players have been singing from the same hymnbook about ratcheting up investment outlays. Alibaba chairman and CEO Daniel Yong Zhang, in a May 13 briefing on the company's March 31 results, took the lead, pledging to invest "all of our incremental profits" this year into core strategic areas.

Analysts and money managers see a trend that could weigh on earnings margins for the coming year or so — by design, some contend — while delivering longer-term payoffs.

The typical response when companies in China find themselves in the regulatory spotlight is to lay low; with anti-monopoly concerns now, laying low means not delivering astonishing profits, said David Choa, Hong Kong-based head of Greater China equities with BNP Paribas Asset Management Asia Ltd.

That may explain why, on the latest round of earnings calls, executives of China's e-commerce heavyweights effectively said they're "going to reinvest every bit of their earnings" this year — and possibly next year as well — in research and development or capital expendi- tures, said Mr. Choa, who is lead portfolio manager for his company's flagship $2.5 billion BNP Paribas China Equity Fund.

Money managers say widely held stocks like Alibaba — down roughly 30% from November after Beijing, reportedly angry after Alibaba founder Jack Ma critiqued China's regulatory approach as outdated, quashed a record IPO planned by the firm's Ant Group fintech arm — are already on bargain hunters' radar screens.

Other e-commerce stocks giving back some of their hefty coronavirus-driven gains this year include Shenzhen-based online games giant Tencent Holdings Ltd., down 23% from its Feb. 18 intraday high following a 51% jump the year before, and Beijing-based online food delivery heavyweight Meituan, off 42% from its Feb. 18 intraday high after a 182% surge for 2020.

This year's correction of China's e-commerce stocks "has been relatively healthy" and Alibaba in particular, at 21 or 22 times earnings, is "looking very attractive," said Catherine Yeung, a Hong Kong-based investment director with Fidelity International.

According to Morningstar Inc. data, Fidelity's $6.6 billion China Consumer Fund picked up more than $200 million worth of Alibaba shares listed in Hong Kong and New York over the first four months of 2021. As of April 30, Alibaba was the fund's biggest holding, with a 9.6% weighting.

The company's still got an "incredibly deep moat," Ms. Yeung said. It remains an e-commerce leader, its ecosystem has a lot of breadth and depth and its management team remains visionary and capable in terms of expanding into areas outside of its primary e-commerce focus, she added.

Likewise, China's regulatory response, initially seen as a takedown of Mr. Ma, has come to be judged as relatively healthy as well.

Beijing chose a moment when China's e-commerce players were being buoyed by a pandemic-related tailwind to pursue a regulatory tightening that was inevitable, given the sector's phenomenal growth, said Guan Shao-Ping, head of Greater China equity with Goldman Sachs Asset Management in Hong Kong.

In this instance, China's regulators just moved to "make sure that the big players are not squeezing out the chance for small innovators to participate in the market as well" — ultimately good for competition and not much different from what regulators elsewhere are looking to do, said Alexander Treves, Hong Kong-based managing director and investment specialist with J.P. Morgan Asset Management.

The argument was that Alibaba would cut out merchants that worked with competing platforms, which is anti-competitive "any way you slice and dice it," agreed Jason Hsu, founder, chairman and chief investment officer with Rayliant Investment Research. In that regard, China's government sitting down with 34 large e-commerce players shouldn't prove grist for the mills of conspiracy theorists arguing that regulators there are looking to punish success, he said.

Analysts, while conceding China's beefed up regulatory stance could muddy the outlook for some companies in the e-commerce sector, seem largely confident the new environment won't trip up a sector that's helped underwrite the country's spectacular growth in recent decades.

J.P. Morgan Asset Management's Mr. Treves said China's e-commerce regulatory tightening hasn't had much impact on the five-year return forecasts the firm's analysts focus on.

"What we've typically been doing is adding on weakness, not selling, because if you like the longer-run story behind this stock and it just sold off, well you just got a cheaper stock," he said.

Morningstar data showed J.P. Morgan Asset Management's $7.4 billion JPM China A fund adding $310 million of Alibaba shares over the first four months of the year. As of April 30, Alibaba was the portfolio's second-largest holding with a weighting of 8%.

In addition to bargain hunting, meanwhile, JPMAM's China funds have been picking up more shares of large companies that have significant weightings in their benchmark indexes as they strove to put to work "very substantial inflows year-to-date," said Mr. Treves.

While declining to provide an exact figure for those flows, Mr. Treves allowed that it was in the "high single-digit billions," which — with a China equities total now of roughly $30 billion — suggests inflows of between 30% and 40% since the start of the year.

BNP Paribas' Mr. Choa said he too has observed a sea change this year in what used to be a wary attitude toward China among institutional investors. A majority now see China "as a core asset class," and is moving to close underweight positions, he said.

Mercer LLC, the New York-based investment consultant, published a paper over the past week pushing for that outcome and more — calling on institutional clients to dedicate 5% to 10% of their equity allocations to China's local A-shares market, a tectonic shift from its 1% weighting now in MSCI's All Country World index.

Simon Coxeter, Mercer's Singapore-based director of strategic research, growth markets said from a strategic perspective, "we think that (local market) China exposure is going to be increasingly important in portfolios."

Should the world move in the direction of a bipolar split between U.S.- and China-dominated spheres or if Chinese firms delist from U.S. exchanges, getting exposure to the unique growth drivers in China's onshore market will become even more crucial, he said.

Mr. Coxeter conceded the 5% to 10% A-shares target would, for most investors, effectively mean going from a considerable underweight to a considerable overweight position. At present, benchmarks like MSCI's Emerging Markets index include only 20% of the A-shares market and "we're advocating a larger allocation than would be implied" by a full inclusion of A shares, he said.

But "from a long-term strategic perspective, thinking about how the world could play out in lots of different ways, you don't want your portfolio to be relegated to the wrong side of history," Mr. Coxeter said.

Meanwhile, investors considering gaining exposure to China equities now could find the market's e-commerce leaders on offer for relatively reasonable valuations this year, money managers say.

The aggressive investment plans of many e-commerce giants could see the "competition cycle" heating up and reported earnings being revised downward over the coming year or more, predicted BNP Paribas' Mr. Choa.

"This year will be much more difficult, to be sure, but we have a long-term investment horizon," he said.