Even as the broader geopolitical environment and global economic uncertainty continue to impact the headlines on China, strong growth prospects underpin several sectors and companies in this vast market. China is forecast to become the world’s largest economy by the end of the decade. To explain the current challenges and opportunities, Pensions & Investments spoke with Dan Chace, portfolio manager at Wasatch Global Investors; Ronald Chan, chief investment officer, equities, Asia (ex-Japan) at Manulife Investment Management; and Jin Zhang, portfolio manager and senior research analyst at Vontobel Asset Management.
Pensions & Investments: Covid-19 has arguably accelerated deglobalization, yet China seems to have emerged, if anything, stronger from the pandemic. What are China’s prospects for growth post-pandemic?
RONALD CHAN: In terms of Covid-19, China has been first in, first out. As the manufacturing hub of the world, China has been able to take advantage of work from home, the demand for [information technology], computer gadgets and related trends. From here on, we expect the momentum will continue, but it will be of a slightly different nature. The demand in China for leisure, domestic travel, gaming and cinemas will all improve. Another ingredient is the demand from the U.S. for Chinese goods, given America’s stimulative monetary and fiscal policies. China, as the manufacturer of the world, should benefit.
A number of sectors have been able to do well due to domestic demand within China but have yet to build additional capacity to cater to the increase in demand from overseas. As interest rates are low, these sectors will likely spend more on [capital expenditure] to respond to this demand. Corporate capex will help China continue with its strong investment and growth cycle, as opposed to just relying on infrastructure spending from the government.
DAN CHACE: One of the things that China has that many emerging markets countries don't have is that it is self-sustaining. We think the prospects for growth are very strong. You can’t put that genie back in the bottle. We're positive that from China’s dual-circulation strategy, there will be growth from a domestic demand component and also from an export component.
JIN ZHANG: I agree with Dan. The Chinese economy is large and diverse. It has a number of different sectors and different drivers. China’s middle class is quite sizable and still growing, which contributes to several positive domestic consumption stories.
One area within domestic consumption that’s an interesting growth theme is snack food. As people are getting busier, the younger generation is actually snacking a lot more than the previous, older generation. This food sector has several good, high-quality companies that are tapping into this trend in domestic consumption and growing well.
P&I: What changes in the Biden Administration’s policies toward China should investors be paying attention to?
ZHANG: We are bottom-up investors, but we are watching these changes carefully. U.S. policies are more coordinated than before. We are very aware of the potential risks and disruptions to previous Chinese business models, and we are watching how these changes will affect industry dynamics. One example is the distrust [between the U.S. and China] that is growing in the technology sector. There could be domestic champions in China that will emerge from this trend, for example in software, and we are watching that side of the situation too.
CHACE: One of the few bipartisan mindsets in the U.S. right now is in the efforts to contain China. I agree with Jin that [the Biden administration’s] policy will be more coordinated. But, as I said before, you can’t put China back in the bottle.
CHAN: America and China are linked economically in several ways, and they rely on each other. So when you talk about the trade tariffs, we don’t see them as being that successful because there are a lot of American companies operating in China. Europe also has a lot of interests in China. The only way that the U.S. can come out ahead in its strategic competition with China is with the help of its allies. Yet none of its allies in Europe or Asia is interested in a cold war (alia Soviet Union in 1970s), since their economies depend heavily on engagement with China, and few of them see China as an existential security threat.
CURRENT PERSPECTIVES ON CHINA
P&I: What are the implications for investors of the technology bifurcation between the U.S. and China, as well as China’s dual-circulation economic strategy?
CHAN: This strategy is really about China gaining more control over long-term domestic growth without losing its role as a manufacturing hub of the world. The reasons behind this policy are rising protectionism around the world and a global economic cycle on the decline. On the domestic part of that equation, it’s about modernizing domestic industry and upgrading consumer necessities so that China is less reliant on foreign products and is self-sufficient, especially in technology.
ZHANG: We want to look outside of this technology bifurcation that you mentioned to the other countries that are in the middle. It could be an investment opportunity if [those country’s companies] do the right thing. For example, Samsung Electronics is a very strong player in semiconductors and technology in general. They supply to both sides of the Pacific, and they are also increasing their production capacity in Texas. If companies like Samsung play their cards right, we will see more investment opportunities.
CHACE: This [technology bifurcation] is really significant, and the nexus of that is in semiconductors specifically. The semiconductor sector is likely to be a flashpoint in trade and diplomatic relations. China is going to invest heavily in its own semiconductor manufacturing capability, and Intel, with some pressure from the [American] government, is going to invest in the U.S.
[The dual-circulation strategy] is keeping China's historical strength in exports but also fostering domestic consumption which, if you look at the data, has done quite well. Domestic consumption has grown considerably, as Jin mentioned.
P&I: What are the most common questions you hear about China from existing or potential institutional clients, and what solutions do you present?
ZHANG: There is definitely a sense of opportunity in China among investors but it is mixed with fear and confusion. We approach investing in China the same way that we approach any other market. We do bottom-up research, a deep dive [into the companies we identify], and we want to own the best, highest-quality businesses. If we do our jobs right, we can buy and hold [these stocks] and bring that benefit of growth to our investors.
One concern we hear is that China’s market itself is relatively new and many companies in it are new to the market. We believe the advantage we have is a very experienced research team with diverse backgrounds, located in the U.S. and Hong Kong. We also have three former journalists on our team. They have become our internal investigative analysts and bring resources and insights that are not accessible to Wall Street research methods. Applied with our team approach, that goes a long way in helping us overcome [the uncertainties] associated with this newness.
CHACE: We hear similar concerns. China has led the world in terms of [initial public offering] activity by number of companies, though not necessarily in terms of capital raised. The market is hugely dynamic. For Wasatch, with our historical legacy in small-cap stocks, that’s something that we like to see. It represents innovation and change, and that brings opportunity for investors. But you need to have the resources to address that as well as an experienced team that can filter through all of that change.
Many potential institutional investors are still trying to figure out how to approach China. Do you pursue China exposure through an emerging markets strategy or, ultimately, will clients want to have a separate China allocation and an EM ex-China allocation? And a separate question within that is, ‘Do you have a greater-China strategy or an Asia strategy or a Hong Kong H-share strategy [Chinese companies listed on the Hong Kong Stock Exchange]?’
Part of the reason that we launched a greater-China strategy has been that the exchange is irrelevant for us. It can be Taiwan with mainland China exposure, ADRs [American depositary receipts, foreign company stocks that trade on U.S. exchanges] with mainland China exposure, Hong Kong companies that are mainland China companies, and then A-shares as well. So the venue to us is irrelevant, relative to the opportunity that we're trying to access.
CHAN: Everyone wants to come to China for the growth, but they don't want the volatility. Clients say, ‘Give me the stuff that’s not in the benchmark.’ They want high-alpha products, off-benchmark products, high-active-shares products.
The Chinese stock market has over 4,500 names, and that number is growing because of the number of [initial public offerings]. The U.S. has 3,500 names, and that number is shrinking because of [merger and acquisition] activity. There are a lot more opportunities in China than in the U.S., especially when the U.S. market is already at the very expensive end of the spectrum.
We offer solutions for investors with different risk appetites. We have a product that is high active shares; another that is All-China so that clients don’t have to decide between onshore China and offshore China or ADR and Hong Kong; and the Greater Bay Area Balanced product, which focuses on the highest-growth elements of China in the Pearl River Delta while managing volatility through fixed-income exposure.
