Slow growth in China will force companies to innovate

Slowing growth in China could prove a boon for investors as it forces companies to innovate with new and higher-quality products, according to First State Investments.

First State Stewart, the firm’s Asia and emerging markets team, said the innovation emerging particularly in the consumer and pharmaceutical sectors “should make the next few years interesting from an investor’s perspective”.

A slowdown in the economy may also lead to more multinational companies developing in China, as firms can no longer rely on domestic customers to drive growth.

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First State runs a range of funds investing in Asia and emerging markets, but several have ‘soft-closed’ by adopting punitive charges to discourage new investments. Its Asia Pacific Leaders and Worldwide Equity funds are still open, though.

The team, headed by Angus Tulloch, has traditionally had an underweight position in China, partly due to its aversion to owning state-owned enterprises and last year he warned of “major problems” in the country’s shadow banking system.

This cautious stance towards the world’s second-largest economy has served the team well since the financial crisis, as China has considerably underperformed both the wider emerging markets and Asia Pacific indices.

China’s poorer showing in markets has been down to concerns over its plummeting rate of growth and First State acknowledged that the slowdown has exposed “the areas in which the corporate sector needs to improve”.

However, in a recent update following a visit to China, the team said that certain sectors within China and stocks were set to be winners in a shift in corporate sentiment and now looked particularly attractive.

The First State Stewart team said the end of the high-growth era meant “consumer companies are increasingly focusing on product mix”, particularly “launching higher-margin products”.

The managers highlighted the food and beverage sector, where margins in Chinese companies were much lower than global peers, but said “with average selling prices rising healthily in a number of consumer segments, there are good opportunities for well-managed companies to thrive”.

The team highlighted Want Want and China Mengniu Dairy as two firms looking to exploit this new higher-margin end of the market.

Another sector that looks set to improve is pharmaceuticals, where First State claims an increasing number of firms are filing drugs with the US Food and Drug Administration, which demonstrates a “move towards the global standard”.

The team said there was also “evidence of more focus on innovation in the sector”, which could provide significant returns to investors.

But the big change in Chinese companies may not just be limited to sectors, but be more wide reaching. The First State team highlighted how almost all the firms they met in China were talking about improving “sales and marketing operations”.