China’s Recovery Shows Positive Signals for Long-Term Investors

As global markets grapple with the impact of the coronavirus pandemic, investors worldwide are seeing downward earnings revisions and closely watching for signs of resurgent growth. They don’t have to dig too deep for those signs in China, where a number of economic and market fundamentals have lifted the country toward recovery more rapidly than many expected, and which continue to underpin long-term share price performance, according to Wenchang Ma, portfolio manager at Ninety One in Hong Kong.

“China’s equity market has held on better than the rest of the world, probably better than what many people, including ourselves, expected initially,” said Ma, a veteran China active equity manager. “China was the first in, first out to experience the pandemic. The government took decisive measures with the lockdown and centralized resources to help areas most in need. They were able to maintain discipline in social distancing, and all that helped lift China out of the crisis as fast as possible,” she said. Chinese equities have seen some downward revisions, she said, but earnings adjustments are already under way in addition to a number of sustainable drivers of alpha for the long-term China equity institutional investor. 

LOOK BEYOND THE RHETORIC

The geopolitical rhetoric between the U.S. and China, which is as high as it’s ever been, and the potential of a second pandemic shock are still risks that investors need to watch for, Ma said. But the Chinese government is using both strong fiscal policy and prudent monetary policy to continue its economic recovery, and its support of market reforms continues to be consistent. Chinese fiscal policy is leading the economic recovery effort by increasing infrastructure spending and, at the same time, encouraging consumption with tax and fee cuts, she said. 

The transformation of China from a more export- and manufacturing-driven economy to one that is more services and consumption-driven continues as well, and the pace of these developments has helped in the recovery. In fact, since China’s exposure to consumption-driven activity is a bit lower as a total proportion of its economy, when compared with many developed economies, China’s economic recovery has actually been slightly faster, Ma said. Several sectors are looking up: “Production levels are close to normal. It’s the same with coal and electricity,” she said. Service sectors like auto sales are already back to last year’s level. Home sales are very resilient. Traffic size in major cities is back to normal levels. Traffic is still lower across cities, and the most impacted has been international travel.” 

“We are quite pleased with the way that our China strategies have performed through the crisis,” said George Varino, managing director and head of U.S. institutional at Ninety One. “In many ways, [performance] has justified the allocations that have taken place already. It speaks to the diversification benefits for the past few years as A-shares were included in the MSCI” indexes, he said.

“Most investors we speak to are looking for the downside protection that China provided in the first quarter,” he said, “certainly compared to the rest of emerging markets and developed markets.” As MSCI includes more A-shares in its indexes over time, he said he expects China to become a more segmented allocation for institutional investors. The ease of access to A-shares through Stock Connect and a strong fund pipeline will draw global investor interest in China, including from the U.S., which has lagged thus far versus the rest of the world, he added.
 

AN ABUNDANCE OF CHOICE

“China is a rare animal, in terms of its size and diversity, that offers a number of opportunity sets to global investors,” Ma said. “We see an abundance of opportunities in terms of sectors and different parts of the economy that we can choose our ideas from.” 

Infrastructure-related subsectors, such as construction machinery and cement in the materials sector, are particularly attractive from an earnings-momentum perspective, with good-quality companies trading at reasonable valuations, she noted. Consumer staples, internet and online shopping, which have all been resilient in the face of the coronavirus, are other sectors she said she likes. 

“Some of these companies have had a long track record, demonstrated their quality management behind the business, and have sustainable long-term drivers. Also, in this kind of environment, they are creating momentum,” Ma said.

Ninety One is not changing its investment philosophy or investment process as it navigates the current situation. “In fact, in this environment, investment discipline is particularly important because that’s what we believe drives long-term alpha,” said Ma. The firm’s proprietary 4Factor process includes quality, valuation, earnings and technicals. “We look for good-quality companies with strong management and a sustainable strategy, reasonable valuation, improving earnings momentum and positive share price technical signals,” she explained, adding that the combination of all four factors is what helps Ninety One identify opportunities that are neglected through market inefficiencies and provide stable returns over the long term. 

The firm’s approach combines an objective computer-based screening tool with vigorous human-based fundamental research to find a short list of high-conviction ideas in Chinese equities, both onshore and offshore, Ma explained. “We often get a question from clients: ‘Is your strategy actually effective in China?’” Ma said, pointing to the firm’s track record, which shows over 10% gross alpha per annum (9.18% net) on average since inception of the strategy¹.

Integration of environmental, social and governance factors is a key component of Ninety One’s philosophy, Ma said, noting that the firm pulls third-party data and conducts deep fundamental research in each of the E, S, and G elements for every company under consideration. ESG in China is still more qualitative than quantitative, but disclosures are improving, led by state-owned enterprises, she said. Corporate governance in China is a big question of concern, which is why it is critical to have local knowledge and investment teams based in China. 

“We grew up here and it helps if we know where to look for risks,” said Ma. Besides identifying core governance risks and conducting constant on-the-ground monitoring, her team engages with management and diverse stakeholders, and actively encourages best practices in governance with companies. 

SILVER LININGS ON THE HORIZON

Despite the headlines of geopolitical tensions and the global slowdown from the pandemic, Ma sees silver linings ahead. “China’s equity market is still largely dominated by local, retail investors and the market demonstrates a lot of behavior bias and inefficiency. This kind of environment is ideal for fundamental bottom-up stock pickers,” Ma said, noting that a disciplined investment process helps to effectively narrow the universe down to high-conviction ideas that deliver long-term alpha. In addition, a number of Chinese companies were able to pivot quickly to the domestic market to find support for earnings in the face of the coronavirus outbreak and potential trade conflict. “Overall, global investors still recognize the growth potential of the Chinese equity market. They look at valuations and potential earnings momentum, and they think about how underrepresented China is in global equity market [indexes]. All [of] that is driving long-term asset allocation decisions on China and that is not going away on the back of COVID-19,” Ma said.

“We’re at the initial stages of what’s going to be a multiyear and probably a multi-decade push, as investors really up their China allocations across the board. We’re just in the infancy of it now,” concurred Varino. ■

¹ 4Factor All China Equity inception date: March 1, 2014. Net performance (net of the highest institutional segregated portfolio management fee) and gross performance (returns will be reduced by management fees and other expenses incurred); income is reinvested in U.S. dollars.

This communication is for informational purposes only. It may discuss general market activity or industry trends and is not intended to be relied upon as a forecast, research or investment advice. The economic and market views presented herein reflect Ninety One’s judgment as of the date shown and are subject to change without notice. There is no guarantee that views and opinions expressed will be correct, and they may not reflect those of Ninety One as a whole; different views may be expressed based on different investment objectives. 
Nothing herein should be construed as an offer to enter into any contract, investment advice, a recommendation of any kind, a solicitation of clients, or an offer to invest in any particular fund, product, investment vehicle or derivative. Investment involves risks. Past performance is not indicative of future performance. Any decision to invest in strategies described herein should be made after reviewing the offering document and conducting such investigation as an investor deems necessary and consulting its own legal, accounting and tax advisors in order to make an independent determination of suitability and consequences of such an investment. A description of risks associated with this strategy can be found in the offering or other disclosure documents. 
Issued by Ninety One, June 2020