China and Hong Kong’s markets have surged by a third since the recent lows last November, as the easing of the pandemic curbs puts these economies back in business. Yet, with both short and long-term opportunities abound, it is not too late for investors to consider increasing their allocations in Chinese equities, says fund manager Abrdn’s head of China equities Nicholas Yeo.

Unlike further monetary tightening undertaken by other major economies in a belated bid to rein in inflation, China is engaging in monetary easing. The easy policy stance coupled with low inflation bolstered economic and earnings growth, providing investors with a more conducive and accommodative market than the rest of the world.

Secondly, the Chinese market is also nurturing smaller innovative companies to become next-generation tech giants. These companies, some of which are semiconductor and automation companies listed on the Shanghai Stock Exchange Science and Technology Innovation Board, are providing 25% to 30% CAGR EPS growth for the next three years, says Yeo.

China is also cheap relative to global peers: The market is trading at a steep discount to its historical averages. As at Dec 8, 2022, on a P/B basis, Chinese companies are trading at a 35% discount, versus emerging markets’ 8% discount and developed markets’ 29% premium.

“Whilst we are caught up with macro regulations, these companies are providing excellent growth but got drowned by the negative press,” says Yeo, referring to China’s tech crackdown. “This is why I believe it is not too late for investors to participate; the P/E to growth ratio is still less than one, which is why it is a good time to buy, especially with a three to the five-year investment horizon.”

The ‘right’ side of the government

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Since relaxing its zero-Covid measures in December last year, China has seen a surge in infections, impacting megacities down to tier-3 cities. The country’s National Health Commission estimated that nearly 37 million people might have been infected with Covid-19 in a day in late December, with nearly 18% of the population likely to contract the virus in the first 20 days of the month.

Yeo does not doubt that infections would continue, causing China to muddle through the year’s first half. He is, however, optimistic that consumption would rise following the first wave of infection, being the main driver for the country’s economic growth this year. “The upper-tier cities will lead the recovery, while the resources are channelled to lower-tier cities to manage infection risks,” He adds that a hybrid immunity can be achieved by the end of the second quarter.

Against this backdrop, Yeo says that investors will be able to find good opportunities by being selective in five areas he considers to be on the “right” side of the government — aspiration, digital, green, healthcare and wealth management.

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The first area — aspiration — refers to the consumer goods and discretionary producers seeing growing demand even in the lockdown periods. These could be producers of premium snacking or alcohol brands, which benefit from the lifestyle inflation among the younger, emerging affluent population in China. According to Yeo, this population will continue to aspire for a higher standard of living and hence be willing to pay more to enjoy these premium products.

As at Dec 31, the Kweichow Moutai — brewer of China’s most famous liquor — takes up 6.3% of the Abrdn All China Sustainable Equity Fund, as indicated in the fund factsheet. China Tourism Group Duty-Free Corp, which, as the name indicates, is in the duty-free retail business. This stock accounted for 2.7% of the fund.

The second, digital, refers to the hardware and software counters in the technology sector. “Although the tech regulatory crackdown has given a bad taste to investors’ mouths, the regulatory enforcements are not unique to China. Other countries such as the US have also enforced similar regulations to achieve similar results, although China’s policy execution and enforcement may be less opaque and uncertain,” says Yeo. Tencent Holdings, China’s leading internet company behind the ubiquitous multi-purpose app WeChat, is the largest holding, taking up 9.8% in the Abrdn All China Sustainable Equity Fund. Meituan, the company behind the popular food delivery app, accounted for 4.8% of the same fund, while e-commerce giants JD.com and Alibaba Group Holdings accounted for 4% and 3.9%, respectively.

China is also becoming more self-sufficient in its technologies to reduce its reliance on component imports. China imported US$381.2 billion ($504 billion) worth of integrated circuits during the first 11 months of last year, buying the chips at a higher cost, given the imported units were lower by 14.4% compared to the same period last year.

This, in turn, created many opportunities for investors to look at the participants of the entire supply chain. For instance, there are good names within the areas of semiconductor equipment suppliers as well as assembly and testing services providers. On the software side, there are localised software and counterparts of foreign brands in enterprise software and cybersecurity that investors can identify.

On the energy front, China imports about US$250 billion worth of oil and gas, says Yeo. Instead of digging for more oil in the South China Sea, the current priority is to decarbonise to reduce the reliance on oil and gas imports and mitigate the risks of hostile foreign relations. It would also solve China’s domestic pollution issues.

For more stories about where money flows, <a class='gtm_see_also_3_inread' style='text-decoration: underline;' href='/section/capital?utm_source=website&utm_medium=article&utm_campaign=ONPAGESEO'>click here for Capital Section</a>

A paper released by the Fairbank Center for Chinese Studies at Harvard University found that China initially made forays into clean energy technology for export before setting up a domestic market when conditions for outward investment and trade turned sour. Today, China leads the world in renewable energy production figures, being the largest producer of wind and solar energy globally.

Over 80% of the solar supply chain is is dominated by China, says Yeo. Battery maker, Contemporary Amperex Technology Co (CATL), accounted for 2.9% of the fund. The Fujian-based company is the world’s largest producer of lithium-ion batteries used mainly in electric vehicles.

Regarding healthcare, Yeo says that China hosts an ageing population — the current median age of the population is 35, but it is set to be 46 by 2050. He adds that there is a huge gap in healthcare, health products and ancillary services to meet the needs of this ongoing trend.

Still, investors need to be selective — within the healthcare sector, companies that Abrdn avoid include generic drug makers, which suffer from a global price push-down. Instead, it invests in research and development companies that provide services to innovative drug makers, which are not subject to price regulations.

The last area with significant investment opportunities in wealth management, on the back of the country’s economic expansion. According to a report published by the Hurun Research Institute and Citic Prudential, the number of Chinese high-net-worth families rose 1.9% in 2021 to nearly 2.1 million, with their aggregate wealth growing 27% to 160 trillion renminbi ($31 trillion).

“Given that it is no longer taboo to talk about death, more Chinese citizens are thinking about the need for insurance and wealth preservation,” says Yeo. China Merchants Bank, which runs a wealth management unit, accounted for 4.1% of the fund. Bank of Ningbo, meanwhile, accounted for 3.2%. Yeo says that China’s life insurance penetration rate is severely low and has even worsened during the pandemic to about 2% to 3%. It is set to grow and consultancy firm Oliver Wyman says China’s life insurance market size is expected to grow by up to 13% per annum after the country’s disposable income per capita hits the US$7,000 to US$10,000 tipping point, reaching an 11% to 13% penetration rate by 2040. Leading insurer AIA Group accounted for 2.9% of the fund.

Additionally, the Chinese government’s move to curb the real estate market to make it less speculative drives wealth to other asset classes, naturally shifting the population’s allocation to equities and fixed income. But Yeo says the real estate sector will continue to be challenging despite its hefty weight towards China’s economy. Over the past few years, the government has implemented policies to curb property prices because of over-leveraging worries. Determining winners in a hazardous environment will be difficult as even the best quality names are struggling with funding issues. He also adds that China’s long-term investment case remains intact, reiterating reopening catalysts, key structural growth and attractive valuations.

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