Where are the opportunities for investing in China?

As a whole, China has high growth characteristics and even though its GDP growth is now single-digit, it still far outstrips that of major western economies.

Much of this growth has been spearheaded by mainland China, rather than Hong Kong, however, as the mainland invests heavily in infrastructure and automation.

For example, Jeremy Lang, co-founder and partner of Ardevora Asset Management, says: “China has sought to move up the value chain into many other areas.

"A move towards automation is the natural progression for the country, which is seeking to transition to a consumer-led economy.” 

From a growth story perspective, an investor should focus on the fundamental developments that matter to the investment universe in question. Nimalan Govender

In turn, this has been helping to drive local and global trade. Maarten-Jan Bakkum, senior emerging markets strategist for NN Investment Partners, explains: “A key driver for emerging markets is the pick-up in global trade, which is partly the result of good growth dynamics in China.

“The recovery in capital flows to emerging markets is the main reason why their financial conditions continue to ease. 

“This is producing the first meaningful pick-up in their credit growth since the 2009-2011 post-Lehman boom. Stronger credit growth, from 6 per cent in quarter one to 8 per cent now, should help give legs to the domestic demand recovery in the coming quarters.”

But does the headline-grabbing growth and infrastructure story for domestic China have room to play out, and will it continue to help fuel a boom in emerging markets and, indeed, elsewhere globally?

Some investment managers believe so. Josh Crabb, head of Asian equities for Old Mutual Global Investors, comments: “We believe China’s domestic CSI 300 index trades on an attractive forward price/earnings multiple of 11.6 times, having significantly underperformed other major emerging indices since the start of 2016.”

He also believes the recent addition of 222 A-shares to the MSCI will boost China’s mainland equity market. “With a market capitalisation of US$7.7trn (£5.97trn), the Chinese equity market is the second largest in the world, although remains underrepresented in major global indices,” he says.

Assuming eventual 100 per cent A-share inclusion, some market analysts are predicting approximately $300bn (£232.6bn) of incremental inflows, which would give China greater international accessibility and lead to vastly improved trading standards. 

Fewer analysts, greater potential

However, greater inclusion and accessibility could mean the current valuation discount cited by Mr Crabb will start to reduce as investors start to understand Chinese corporates better and greater numbers of analysts pore over the details of domestically listed companies.

According to Gary Monaghan, an investment director based in Hong Kong for Fidelity International, the fact that global analysts have not rushed to the mainland means there are some “incredible” investment opportunities in the mainland market for long-term investors. 

He says as fewer analysts have covered the A-shares market, there is greater potential for investors to pick up a bargain at the moment.

"There are thousands of companies undiscovered by international investors listed in Shanghai and Shenzhen, and less coverage means more opportunities for mispricing. 

“Also, China mainland companies are well ingrained in China’s long-term structural growth story of a wealthier middle class, more consumption and the shift to online.”

However, Mr Monaghan believes there is still some attractive valuation differentials to exploit, both on the mainland and in Hong Kong. He explains: “The small-cap market in Hong Kong currently looks undervalued compared with other parts of both the Hong Kong and China mainland markets.”

Large-cap opportunities

According to Charles Sunnucks, assistant fund manager on Jupiter’s Global Emerging Markets team, overseas investors could benefit from mainland large-cap opportunities in particular.

He cites a “meaningful difference” in the types of investments foreign and local investors find attractive, which creates positive pricing differentials for international investors.

Mr Sunnucks explains: “Chinese investors are dominated by retail money, and typically chase after smaller firms with enough volatility to potentially make big gains quickly.

“International investors meanwhile, tend to have a far greater preference for larger cap businesses. 

“The result of this disparity is that while smaller cap A-share companies are often excessively expensive, there are a number of very compelling larger cap opportunities, well positioned to do well from greater foreign flows.”

Howard Wang, manager of the JPMorgan Chinese Investment Trust, believes although optimism about the Chinese economy may have cooled, the longer-term outlook is positive.

He says: “In terms of market outlook and positioning, while macro-economic optimism has likely peaked in the near term, the still substantial underlying economic strength in China affords policy-makers room to rein back stimulus policies and to normalise financial conditions.”

Framing the discussion

However, rather than simply consider the growth opportunity in terms of economic metrics, Nimalan Govender, portfolio manager, Asia Pacific, for Morningstar Investment Management Group, says investors would be "better placed framing the discussion around the 'investment opportunity'."

He says: "From a growth story perspective, an investor should focus on the fundamental developments that matter to the investment universe in question. In this regard, China and Hong Kong are two very different markets."

For example, he says in Hong Kong, profit margins are likely to be misleading as they have become very elevated following the property boom.

In mainland China, he says sector diversification means profit margins are less susceptible to concentrated influences related to the property boom.

And the inclusion of 222 stocks into the MSCI index also poses a question for Mr Govender. He adds: "There are questions about capital flows and the effect this could have on the Hong Kong market. 

"Will the inclusion act as a trigger for capital transfers to and from Hong Kong? This raises a potential inflection point that could see prices shift based on a change in the opportunity set."

simoney.kyriakou@ft.com