Can China funds claw their way back in Year of Rooster?

The start of the Year of the Rooster is the beginning of Chinese Lunar New Year Golden Week.

This week-long national holiday can have a big impact on global financial markets so FTAdviser asked investment experts what they think the next 12 months has in store for China and your client’s investments in the region.

A re-occurring name that kept on cropping up when speaking to investment experts was President Donald Trump.

Fund managers with a China focus are assessing what impact President Trump’s isolationist stance will have on the region.

Nicholas Yeo, head of equities for China and Hong Kong at Aberdeen and manager on Aberdeen New Dawn and Aberdeen Asian Smaller Companies investment trusts, said external shocks to growth were most likely to come in the form of trade tariffs if President Trump succumbs to his anti-globalisation instincts. 

Mr Yeo said this would curtail Chinese exports in the short term, and have a knock-on effect on bank lending and manufacturing. 

In the long term, however, he said it would compel policymakers to accelerate structural reform of outmoded state-owned sectors.

Mr Yeo said: “We believe China has the resources and policy tools to guard against financial instability. 

“To preserve growth, we can expect Beijing to step in and stimulate its economy, more likely through infrastructure spending than a return to property stimulus. 

“It is all part and parcel of China’s boom-bust transition from an insulated and impoverished nation of farmers to a liberalised and prosperous global powerhouse.  For investors it translates into stock market volatility.”

Sheridan Admans, investment research manager at The Share Centre, said a key risk to the Chinese economy in 2017 is the US FED raising interest rates as this will likely lead to an increase in the pace of outflows from China. 

Howard Wang, manager of JPMorgan Chinese Investment Trust, said the outcome of the US presidential election could also result in investors potentially seeing a further tightening of financial conditions in China.

He said this would be in response to pressure on the currency, as authorities attempt to buy time for an easing in the US dollar rally. 

Bigger risks

But Dale Nicholls, portfolio manager of Fidelity China Special Situations, said a bigger risk facing China than President Trump’s approach to dictating US policy was the growth in credit.

China’s debt to GDP ratio is high at more than 200 per cent.

While there have been signs of the growth in credit slowing, particularly in the so-called shadow banking area, Mr Nicholls said more progress needs to be made here.

He said: “As a stock picker, one of the biggest disappointments under the current regime has been the lack of state owned enterprise (SOE) reform. 

“However, the Year of the Rooster could see some progress here. We have seen some pockets of state owned enterprise reform, such as some company management teams having their pay more aligned to shareholder returns. 

“Big wholesale state owned enterprise changes have so far eluded us, but there have been signs this could change.”

A strong theme emerging among fund managers was the focus on ‘new’ China as it transitions to a consumer and services led economy. 

Mr Nicholls said overall his portfolio continues to focus mostly on ‘New’ China and invests in areas of the market related to China’s modernisation. 

New China

Roddy Snell, deputy manager of Pacific Horizon Investment Trust, agreed that it is these new shoots that should be focussed on.

He said too much focus was given to the fact China’s growth rate is slowing as this does not necessarily mean the country is on the verge of economic collapse. 

Mr Snell said: “Amid all the gloomy headlines, it is easy to lose sight of the fact that China is undergoing a planned economic transition from an investment to a consumer and services led economy, which is imperative to securing the long-term success of the country. 

“Yes, there will be casualties from the old economy, in particular the state owned enterprises that continue to destroy capital and the country’s banks that fund their operations, but it would be foolish to dismiss Chinese companies as an investment opportunity outright. 

“For those with long-term investment horizons able to look beyond the current environment of slower GDP growth, the new consumer-led economy presents investors with a number of the most interesting investment opportunities in the emerging markets universe.”

According to Mr Snell there are three core drivers of this consumption story: economic rebalancing; innovation and technology; and, China’s world class technology companies. 

Combined, Mr Snell said these are likely to make China one of, if not the, world’s best consumption stories.

Economic growth in China continues to be supported by stimulus, as the region reported last week that its economy grew faster than expected at 6.8 per cent in the fourth quarter, boosted by more government spending and record bank lending.

JP Morgan’s Mr Wang said as a long-term bottom-up stock picker primarily looking for quality growth franchises, he believes “New China” businesses should broadly outperform over longer time periods as interest in industrial Old China declines. 

He said: “With improving access to the onshore China markets and what we believe to be the eventual inclusion of A-shares in global indices, the A-share market will increasingly offer the type of companies that reflect the dynamic and growing domestic economies which make up the evolving economic composition of New China.

“We are currently invested in the consumer, healthcare, technology/internet and environmental services sectors which we believe will offer the most exciting investment opportunities over the next couple of years. 

“With a new interest rate regime on the horizon, we believe beneficiaries of the reflationary environment have grounds to gain as well.”

Reasons to be cheerful

Rathbones’ Asset Allocation strategist Ed Smith agrees there are good reasons to be optimistic about China’s growth in 2017.

Mr Smith said there are several reasons to be more optimistic on the country’s prospects this year.

He said his projections suggest the downturn in Chinese growth troughed in the fourth quarter of 2015 and reaccelerated throughout last year. 

Although the rapidity of debt accumulation is alarming, Mr Smith said it is concentrated in the state-owned sector and issued by state owned banks. 

This presents policymakers with far more levers to pull in order to avert any dislocating impact on monetary institutions.

The reorientation to a consumer-driven economy also looks well advanced, according to Mr Smith. 

Concerns about capital outflows are repeatedly overblown, he added. 

Mr Smith estimated that 70 per cent of net outflows in 2016 were due to benign or even positive forces, such as an increase in overseas acquisitions by Chinese firms or the repayment of dollar-denominated debt, which diversifies the asset base and strengthens financial soundness respectively.

So, clearly as we enter the Year of the Rooster, managers focussed on the region believe despite President Trump’s protectionist policies there is still much to crow to clients about when it comes to China.

emma.hughes@ft.com