Foreign investment

Bargains behind the Great Wall

Investors should consider buying into increasingly accessible Chinese markets, given an enticing combination of good valuations and low correlation with other markets, which makes China an attractive option in terms of potential returns and diversification.

China will continue to have a strong influence over global economies over the years ahead. Although large and robust, China’s economy has the additional benefit of being relatively young with much potential to grow.

Though, Chinese inflation ran higher in 2009 as a result of stimulus measures applied after the financial crisis. This led to a tightening in monetary policy in 2010 and 2011 which, together with Europe’s problems, caused the slowdown in China’s growth.

However, the Chinese economy has the capacity to continue on its impressive growth path. A trend that supports this view includes the rising disposable incomes that are expected to continue growing.

Although the Chinese population is getting wealthier, China’s gross domestic product per capita is still only at about 15% of levels for the United States, European Union and Japan – indicating much potential for continued growth.

From an investment perspective, China is slowly opening its markets to the world, allowing for the inclusion of Chinese assets in investment portfolios, and changing the traditional view that the country was not an accessible investment opportunity due to restrictions.

“Investors will increasingly look at China as a bigger part of their portfolios, particularly as Chinese equities are currently available at very cheap valuation levels. With the opening up of markets, this is a good time to invest in China’s potential,” says Liang Du, portfolio manager at Prescient Investment Management.

In 2007, the Chinese stock market was roaring ahead, trading at a price earnings ratio of over 60 when the rest of the world was on a PE of around 15. This level of overvaluation priced in Chinese growth of 8.5% above that of the rest of the world for the next 15 years – too bullish a scenario even for strongly growing China. 

“Today the situation is the opposite. China has been one of the worst-performing equity markets since the 2008 crash. Despite company earnings growing by 70% since the crisis, the share market remains around 30% below its peak. This represents a great opportunity,” says Du.

Prescient Investment Management was recently awarded a licence to buy Chinese stocks and bonds by the China Securities Regulatory Commission. This opens the way for Prescient to set up a China Fund, investing in bonds, cash and equity by year-end.

Prescient’s licence was granted under the Qualified Foreign Institutional Investor programme, which allows foreign investors to buy Chinese securities as part of a broader reform of the country's financial markets.

Du explains: “The investment quotas allow asset managers to invest in Chinese shares on the Shanghai and Shenzhen stock exchanges. Without the quota, investors can only access roughly 150 Chinese companies that are dual-listed or listed in Hong Kong. With the quota, they are able to buy into over 2 000 shares listed in mainland China, accessing companies that would otherwise not be investable.

“Another factor that makes it attractive is how uncorrelated the returns of China are to South Africa and the developed world," he adds. "Globalisation has played a large role in the domestic market trading in a correlated manner with the US, EU, Brazil and India. Mainland China remains an outlier, trading in a different pattern to the rest.”

Including China in portfolios thus offers a diversification benefit (i.e. extra return for no increase in portfolio risk).

Du says direct investment access to mainland China is important because the more conventional routes for investment into China via Taiwan and Hong Kong-listed companies are highly correlated to global markets.

Staff reporter

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Issue 2020