China has had a rough 2021. With a global reopening of the economy, stocks that did well in 2020 struggled to repeat the success. Then, the government brought in regulation to even out income inequality, hitting the tech and education sectors. Mega-cap companies like Alibaba (BABA) and Tencent (00700) saw their market value slashed in the tech sell-off.
For years, China’s growth has been an unmissable opportunity for investors, but as we recently discovered, it has only had half the equity market returns of the US since 2011. And with the recent concerns around property developer Evergrande, investors are right to be anxious about market and political risk in the country.
But where there is flux there is opportunity. Several fund managers believe the current environment is providing opportunities for the innovation and consumer sectors, with plenty of investment prospects.
The policies support a shift towards a goal of ‘common prosperity’, modernising the economy and ensuring equal access of opportunities and resources across the country, meaning the playing field is levelling out for rising-star companies.
There will be growing pains in the short term, Paras Anand, chief investment officer of Asia Pacific at Fidelity International, notes. “However, the reforms should drive long-term gains. New regulations covering education, healthcare and property sectors should increase disposable household income, which will in turn lead to increased spending on consumption and services and thereby rebalance the economy in that direction.”
More Regulation to Come
Chinese markets do not seem to be out of the woods just jet though. According to Hugh Gimber, global market strategist at JP Morgan Asset Management, policymakers still view some industries and companies to be misaligned with long-term social goals, making more intervention likely – and he thinks the financial sector and other sides of the technology space could be up next.
Attracting foreign capital is however another long-term objective for the country’s leadership. “Therefore they’ll err on the side of caution when considering how future changes will be viewed by the international investment community,” Gimber says. “Ultimately, this is a story where growth looks a little lower in China, but it’s more sustainable and it’s more inclusive, and that’s no bad thing for equity investors.”
So which stocks do fund managers think are set to benefit?
Aberdeen Standard’s Adrian Lim and Pruksa Iamthongthong, who managed the Bronze-rated Asia Dragon investment trust (DGN), believe in two small cap ideas, which they think are unlikely to be impacted by the current regulatory push that is focused on the large caps.
Chacha Food (002557) is among China’s leading nut producers with well-established brands, including the largest roasted seeds brand locally. This reflects its stringent quality control in its production line and supply chain. “We see high growth potential for Chacha, as the highly fragmented industry presents a consolidation opportunity for a focused, vertically integrated player with a solid brand portfolio,” they say.
Tongcheng-Elong (00780) has Tencent and Trip.com as its two largest shareholders. It is the biggest online travel agency by monthly active users in China, offering mainly air, train and bus tickets as well as hotel bookings. The company enjoys superior margins as it has access to big user bases that enable it to acquire customers at a relatively lower cost. Management is also keen to improve cross-selling between its ticketing and accommodation businesses. The Dragon Trust directors see TCEL as “well-placed to benefit from increasing domestic travel among those living in lower-tier cities”.
Mass Market Production
Morningstar’s equity analyst Ivan Su adds two more beneficiaries to the list: Yum China (YUMC) and ANTA Sports (02020). In a recent video, he said regulation will benefit businesses with large exposure, selling mass-market products, like apparel, footwear, food or cars.
Yum China is the country’s largest restaurant group, operating franchises like KFC and Pizza Hut – and it will benefit from the growing middle class (who tends to eat the most fast food). On the other hand, ANTA Sports operates a dozen sportswear brands, and is set to grow as that same middle class pay more attention to health and wellbeing.