China too big to ignore, but policy will dictate growth, investors say

China's growth outlook remains murky but global investors can't afford to ignore the world's second-largest economy, although factors such as domestic policies, geopolitical developments and consumer sentiment will decide its growth trajectory, investment managers said.

They also argue that upcoming restrictions by the U.S. and its partners on the flow of certain technologies to China has bifurcated the world scientific community and will hurt the global economy, even as some investors outside of the West, such as the Middle East, continue to be bullish on the country.

"The nominal growth outlook for China remains fairly subdued. That's in stark contrast to, for example, India, or, for example, Japan, where you're seeing very interesting, upbeat, supportive, nominal growth," said Ben Powell, Singapore-based managing director and chief investment strategist for Asia-Pacific at the BlackRock Investment Institute, during a media outlook briefing.

"China will continue to see relatively low real growth and relatively low inflation … as China continues to deal with different but significant challenges both overseas and domestically," he added.

A government clampdown in 2020 prevented over-leveraged property developers from borrowing further, sparking off a real estate crisis in China, and dampening consumer sentiment as households continue to hoard savings. Alarm bells also have sounded over heavily indebted local governments, and Moody's on Dec. 5 lowered the outlook for China's A1 debt rating to negative from stable.

In August, U.S. President Joe Biden, citing national security, issued a ban on outward investment to China and the special administrative regions of Hong Kong and Macau that included advanced computing chips and microelectronics, quantum technology and artificial intelligence.

Pension funds in the U.S. also have felt the pressure. The Federal Retirement Thrift Investment Board, Washington, on Nov. 14 voted unanimously to change the benchmark for its international fund to an index that excludes China and Hong Kong.

Global investment managers agreed that domestic policies will have a big part to play in providing support to growth and investment potential.

"At the federal level, the government has the firepower to do a little bit more support. But the government is also clearly very focused on managing financial risks. So I think quite understandably, authorities in China are being very cautious in exactly how much stimulus they want to put into the economy," Powell said.

BlackRock had $9.1 trillion in assets under management as of Sept. 30.

Consumer and investor sentiment toward China has also been subdued over the past year, and it is unclear if that will change in 2024, the investment managers agreed.

Many institutional investors are underallocated to China at the moment, so the question is when investors will re-enter the market, said Vivian Tang, the Hong Kong-based head of institutional clients in Asia-Pacific at abrdn, in an interview.

She added that she does not have a crystal ball that will predict when investor interest will return to China, but given China's fundamentals and its importance in terms of global economic growth, investors cannot ignore it.

"In terms of our approach, although a lot of investors are still concerned about the policies, growth prospects, domestic consumption, etc., from our perspective, our approach is really bottom-up … From an absolute returns perspective, we are still seeing a lot of interesting companies, (which) as an investor we are very comfortable to invest in and hold for the long term," she said.

For instance, even though near-term potential depends heavily on policies and external factors, long-term structural trends point toward domestic consumption as an area that presents opportunities from a bottom-up perspective, she said.

She also added that benchmark-oriented investors such as pension funds that work on a relative return basis should also consider the fact that China is a significant part of emerging markets benchmarks, so they might miss targets if they are underallocated to China.

China has the heaviest weighting in the MSCI Emerging Markets index and FTSE Emerging index at 28.39% and 31.03%, respectively.

Abrdn managed and administered £496 billion ($626 billion) of assets for clients as of June 30. The firm managed £21.2 billion in APAC equities as of June 30 and the funds under management of abrdn's largest China A fund was $2.4 billion as of Nov. 30. Abrdn does not disclose the size of its China investments, a spokesperson said.

China has one of the weakest structural growth stories, but valuations currently are attractive, said Kamal Bhatia, president and chief investment strategist of Principal Asset Management, in an interview on a visit to Singapore.

Principal managed $517.8 billion as of June 30.

"Historically, people have assumed in Asia outlook means GDP growth … (But) from our seat, it's probably more interesting to think about the outlook as an intersection of things like GDP growth, but also where valuation is," he said.

On the policy front, China has gotten smart about where it provides capital support, he observed. "I think for the first time, the government had realized that there are going to be zombie businesses that they don't want to use good capital to support," he said.

"They have believed that for the public good, you need to keep certain things going. And they did that a little bit with the banks. I think they've become selective of which banks to support and which banks to let go of because if they see a structural issue in a region or the balance sheet, they are realizing there's going to be pain," he said.

The Chinese government did the same with property developers, but in recent years decided to be selective with the developers they want to bail out. China Vanke, the second-largest developer in the country in terms of sales, received funding from a state-backed shareholder in November after concerns about its liquidity were raised in October.

However, other large property companies such as Country Garden Holdings and China Evergrande Group have not been given such help even as they defaulted on some of their debt.

Principal is taking a cautious approach to China's macro outlook, but is optimistic on the micro front, as it continues to look at individual sectors to spot opportunities, said Howe Chung Wan, head of Asia fixed income.

Even amid a cyclical slowdown, he is hopeful for a bounce in certain sectors such as electronics, which had a good run during the pandemic but has since reached "a very low bottom in the electronics cycle," he said.

"And then the world is starting to realize actually the U.S. economy feels relatively OK. And so this bounce that we are seeing is fairly cyclical in China. So we're hopeful about that," he said.

He also believes that the dust is settling for the technology sector in China. For instance, even though Alibaba Group pulled the plug on the initial public offering plans for its cloud business, other parts of the business are moving ahead with funding plans, he said.

In September, Alibaba's logistics company Cainiao Smart Logistics Network applied for an IPO in Hong Kong. It also pulled plans for an IPO for its grocery unit Freshippo, but said that its international digital commerce group, which comprises various e-commerce sites such as Lazada and AliExpress, was preparing for external fundraising.

"Many of the monopolistic behaviors that were punished have been reversed as well. So you can see from a private sector point of view, (authorities) are selective in where they are allowing some of these to reopen and be supportive to the economy, (which) shows that they are rational," Wan said.

Even though asset owners from the West remain bearish on China, Middle Eastern investors continue to invest in Chinese public and private assets.

"Middle Eastern investors in general, are still very bullish on China for the long term ... They don't see the North American investment community in China, they don't see the European investment community in China in the way that they did two or three years ago, but they're still full on," said Rich Nuzum, executive director for investments and global chief investment strategist at Mercer.

"From our perspective, the case for China at this point is one about improvement from a low base in terms of expectations, and about valuation. So as we sit here today, the price-earnings ratio on a forward-looking basis for onshore Chinese equities is about nine times EBITDA. And if we look at the U.S. stock market, it's in the 20s. So for $1 that a global investor puts into China, you're getting twice the earnings yield," he said.

Geopolitical risk has had an impact on trade and foreign direct investment in China, in particular, the restrictions on flows of critical technologies to China by the U.S. and some of its partners, he said.

"That's bifurcated a scientific community and a global venture capital community that had been one community historically … By bifurcating the scientific community, by bifurcating the venture capital community, we're telling the global economy to not run as fast (in the race for technological development)," he said.

"And so I've been a China bull for 28 of the last 31 years since I first backpacked around China in 1981. And, and I've been right to be a China bull for 20 years. But the geopolitical tensions, the bifurcation of the scientific and venture capital communities are a problem for China," he said.