SINGAPORE (May 29): China’s three-decade-long track record of economic growth has faltered somewhat in the last two years, following heightened tensions with the United States. This new geopolitical environment has set the two economic superpowers on a path towards decoupling.
Nevertheless, Chinese markets offer investors attractive opportunities to tap into a dynamic emerging economy. Fundamental drivers such as better-than-expected consumer demand, continuing urbanisation and growing automation remain intact, while China’s ageing population will create greater demand for healthcare and insurance.
Much of the combative rhetoric about decoupling is merely short-term sabre-rattling and does not reflect business sentiments on the ground, Yu Rui, vice-president of ETF sales at Global X of Mirae Asset Global Investments (HK), tells The Edge Singapore in an interview.
Chinese firms are still making their debuts on the US stock markets, though tighter Nasdaq regulations may make US IPOs more difficult for smaller firms. On May 8, Kingsoft Cloud Holdings became the first Chinese firm to offer its shares in the US since the Covid-19 pandemic. US firms, despite being urged by their politicians to quit China, are reluctant to do so. Extensive supply chains made up of well-honed local contractors are difficult to replicate elsewhere.
“Even if supply chains are rerouted to other countries in Asia, I am not so worried,” says Yu. The Chinese government is already hoping to build up high-end manufacturing industries such as electric vehicles in China, meaning that it will largely be labour-intensive industries that will be pushed out. Older industries will be consolidated by larger firms which can adopt more automation while firms that lag behind lose out, he says.
“China’s old economic model relied on exports and investment to fuel growth, but now services and domestic consumption are leading, and exports have fallen below 20% of total output. We see China’s growth prospects closely aligned with homegrown brands that can compete in quality, design and functionality with luxury brands,” notes a Blackrock article.
Made in China 2025
According to Yu, the main challenge preventing investors from fully realising the significant growth potential of the Chinese market is their “traditional” approach towards investing in China. Most investors tend to concentrate on established “market cap” firms in the CSI300 and Shanghai Component Index. Such firms, while better understood by investors and seemingly more secure, may not have much room left to grow.
The new drivers for Chinese growth are likely to be emerging industries like FinTech and biotechnology that form the backbone of the Fourth Industrial Revolution. Recognising the need to move up the value chain and restructure China’s economy, the government has put in place the “Made in China 2025” policy to encourage the development of local high-end industries to take advantage of significant potential growth in this area. Investing in these areas will give investors a first mover advantage in obtaining a share of these promising new sectors.
“Chinese companies from more traditional high-tech sectors like aerospace, machine tools, or software engineering face the challenge of catching up with foreign competitors. This is completely different for sectors crucial to the fourth industrial revolution. Technology gaps in these fields are more fluid, and China sees the opportunity to assume a leading position right from the start,” says a report by the Berlin-based Mercator Institute for China Studies.
With technology life cycles being so much shorter in these sectors, investors need to pre-empt trends within these sectors to maximise returns on investment. As many of these trends often affect multiple sectors of the economy, developing a traditional investment strategy that is silo-ed within traditional sectoral categories may limit investors from taking full advantage of the opportunities made available by China’s economic restructuring. Investing with thematic funds — organised around broad themes such as “millennials”, “intelligent cities” and “New Silk Road” — may help investors overcome these limitations.
Yu believes that China is particularly well-suited to thematic investment due to its strong growth potential as an emerging market on top of its government’s push for domestic innovation. The multitude of socio-economic challenges the country faces as a newly-industrialised country such as an ageing population are likely to generate strong demand for new technological solutions going forward. Thematic investing is increasingly popular among younger investors as they seek to tap into future industries, while institutional investors mainly use it for tactical allocation.
Yu further advocates the use of exchange traded funds (ETFs) to help investors avoid “putting all their eggs in one basket” by buying into a selection of stocks rather than individual equities. However, he reminds international investors — with the on-going geopolitical uncertainties — to be mindful of currency risks when investing in Chinese thematic ETFs priced in the RMB.
Other finance industry professionals point out other kinds of risks inherent in thematic funds. “In effect, you’re placing three different bets,” says Ian Tam, director of investment research, Canada, at Morningstar.
“The first bet is that you are picking the right theme. Second bet is that you’re picking the best fund that subscribes to that theme. And the third bet is betting that the market has not already priced in the potential of that theme. So, the odds of winning all three bets is going to be low, but the payoff can be significant,” says Tam, who also notes that the survivability of such funds is only 10% over a 15-year period.
Yu is therefore recommending trends that will likely remain lucrative in the long-run. One of these is the biotechnology sector, and the other is cloud computing. Both sectors enjoy strong state support from the Chinese government.
The “Made in China 2025” masterplan has included biotechnology as one of the key pillars. This has the effect of spurring on capital market activities in this sector. The Hong Kong Exchange, for example, has relaxed rules to allow pre-revenue companies in this sector to list. While most Chinese biotech companies are relatively new — and yet profitable — they are fast-growing, and investors are eager to support. Five of the world’s 10 biggest biotech initial public offerings in the first half of this year were of Chinese companies, which collectively raised US$1.6 billion ($2.26 billion).
Part of this drive towards developing a domestic biotechnology industry stems from China’s ageing population — the government wishes to improve access to generic drugs to cater to the medical needs of China’s large population. “One drugs executive in China says that the government’s main motive for overhaul, as with many reforms, is to preserve social stability as more patients ask why highly effective drugs for their illnesses that are used in America are not available in China,” says The Economist, which also highlights the increasing influx of skilled Chinese biotechnology talent from work and studies abroad.
Another theme, cloud computing, is riding on a fast-growing market. A survey by research firm Canalys highlights that more than 73% of China’s profitable cloud computing market was controlled by domestic firms. “For full-year 2019, cloud infrastructure services spend in China increased 63.7% to exceed US$10.7 billion. Alibaba Cloud was ranked number one, accounting for 46.1% of the market. Tencent Cloud was the second largest, with a 17.3% share. AWS was third, followed by Baidu AI Cloud,” it reports. Yu observes that cloud computing only constitutes 0.04% of China’s GDP vis-a-vis 0.5% in the US, giving it significant room for growth.
As China races to grow its digital economy, the demand for more cloud computing infrastructure will grow in tandem. In fact, the Covid-19 outbreak has further accelerated the already rapid digitalisation of the Chinese economy as the country transitions towards a gig economy. With technology a growing part of people’s lives, hospitals and government agencies in China are increasingly digitalising their processes, while Big Data has become crucial for e-commerce businesses to spot the next big business trends.
The rapid growth of domestic firms in both these sectors on top of import-substitution policies by the government means that these sectors may be relatively insulated from supply chain risks posed by an increasingly averse trade environment. “We have been advising clients investing in China to conduct a revenue breakdown on sectors to see how much exposure they have to the domestic market,” says Yu, who notes that some cloud computing firms may face short-run ramifications from supply chain risks since some of their business is done in the US.
In the post-Covid-19 world, observers are watching if China’s previously much-vaunted Belt and Road Initiative (BRI) will turn more subdued, as Beijing focuses on domestic economic recovery. Yet, China’s commitment to BRI is likely to remain high due to the central importance of the programme to China’s influential President Xi Jinping. So crucial is the BRI that it was even directly incorporated into the Chinese Communist Party Constitution at its 19th Party Congress.
The BRI, in fact, can be a platform to ramp up economic recovery plans. “If policymakers attempt to engineer a V-shaped speedy recovery post-Covid-19, international economic stimuli like the BRI will be the key to putting the feeble world economy back on its feet. More countries could embrace the BRI as a result,” notes Dr Ji Xianbai, associate fellow at the EU Centre in Singapore, in an op-ed for The Diplomat.
Assuming the geopolitical tensions do not subside, there will be more Chinese manufacturers compelled to deal with disrupted supply chains. Yet, there will also be Chinese manufacturers of steel, concrete, telecommunication equipment and anything that can be exported for cross-border infrastructure development, that will still enjoy some business thanks to the BRI. By extension, funds built on this theme will be something investors can look at as well.
“These products are likely to remain stable within an up-and-down range and any negative impacts if any is likely to be limited. Improved access will likely pave the way for China’s future export business, and investors should look at products that China will want to export next,” says Yu.