What to be aware of before investing in China

One of the biggest issues is the level of political interference in the economy and in the companies making up the A-Shares index, and the way in which policy can have significant effects on both the domestic and international markets. 

For example, two years ago, as sister newspaper Investment Adviser has commented recently, the country devalued the yuan in a surprise move, a shockwave that was felt globally, leading to Black Monday 2015.

The volatility index (Vix) went into hyperdrive, the Dow Jones index shed 588 points and the FTSE 100 lost £74bn in a day’s trading. 

Since then, the country embarked on significant fiscal stimulus programmes, attempting to reflate the economy and are now trying to rein it back in.

Finding investment opportunities requires an investor to think well beyond economic growth prospects. Cyrique Bourbon

But the problem, as Arif Husain, head of international fixed income at T Rowe Price, explains, is the heavy-handed manner in which economic measures are used.

“The cause for concern is that China is applying the brakes again. Of particular concern is the fact, based on past evidence, that the country tends not to calibrate its economic measures.

“When it touches the brake, it tends to flatten it.”

He points to the fact the People’s Bank of China (PBoC) has raised short-term interest rates three times this year already, and between March and April, the China Banking Regulatory Commission released not one but seven documents revealing tighter financial regulations.

“In addition,” says Mr Husain, ‘some 55 Chinese cities have introduced 160 cooling measures to curb rising house prices. If we accept the world’s recent growth spurt can be traced back to China’s 2016 stimulus package, it should follow that we need to be concerned now the stimulus is being taken away.”

Damn lies and statistics

Analysts Fathom claim to have been “sceptical” of official Chinese GDP statistics, and believe that while the government is doubling down on its strategy of investment and export-led growth, this growth path is “unsustainable” over the medium term.

In a July analysis piece from Fathom, writer Jess Baker comments: “There is strong reason to believe Chinese GDP statistics are less than fully reliable. 

“For one, quarterly Chinese GDP statistics are released suspiciously early, three weeks after quarter-end, compared to four weeks in the US, UK and euro area and seven weeks in Japan.

"Given that China is a developing economy, which is much larger than the UK and Japan, one would expect its GDP to be more challenging to calculate.”

However, as the chart below shows, absolute revisions to the first official estimate of GDP growth have been remarkably low in recent years (much lower than in the UK or Japan), and estimates have come in suspiciously close to target, Fathom believes.

She adds: “Either Chinese statisticians have had an incredible improvement in their ability to estimate GDP, or there is something fishy going on. Given that our China Momentum Indicator also demonstrates a significant slowing in economic activity from around 2013, which is not reflected in official data, we would opt for the latter explanation.”

Mr Husain adds: “China is a potential risk about which the market seems too complacent. Sentiment towards China tends to be herd-like. One moment, everybody is crowding onto one side to the boat; the next, they are on the other side.”

Debt rising

There are also higher levels of debt creeping into the Chinese economy. While these look manageable, especially considering the higher levels of debt in the US, for example, (see the chart below), debt could still act as a drag on corporate Chinese activity.

However, the house view from Rathbones is pretty sanguine about the overall effect of this.

According to analysis: "Fears that a debt crisis in China could weigh on global growth look overblown, given high levels of national savings."

Diversification benefits

But while such risks persist, this should not mean clients have no exposure to the country in their portfolios.

Those who have studiously avoided mainland China over the past decade will have missed out on significant equity growth.

According to data from Morningstar, mainland China stocks have fared considerably well over the medium-term.

While short-term performance has proved more volatile for the pure China play than the emerging market index, three- and five-year cumulative performance has far outstripped the index, as the table below shows.

As Cyrique Bourbon, portfolio manager, EMA, for Morningstar Investment Management, comments: "Ultimately, finding investment opportunities requires an investor to think well beyond economic growth prospects.

"This is a well-documented fallacy among the investment community, as the link between equity market returns and GDP growth is weak.

"From an investment selection perspective, there is scope for active management to add value in mainland China if fees are contained. 

"Lastly, the choice between a standalone allocation or as part of a broader emerging market allocation must be contemplated seriously. Emerging markets are a very diverse opportunity set."

Gary Monaghan, an investment director based in Hong Kong for Fidelity International, believes advisers should be aware of the various potential bumps, and make clients aware of them, but urges long-term investors not to avoid the sleeping dragon completely.

Mr Monaghan advises: “China’s influence in capital markets will only grow over time as its market grows and access improves.

“There will be bumps along the way – don’t forget, it is still an emerging market – but long-term investors are set to benefit from the long-term structural growth and changing economic structures we are seeing on the ground.”

simoney.kyriakou@ft.com