China looks to the Year of the Tiger: Are its investment prospects burning bright, and what are the options for investors?

The year of the Ox, which according to the Chinese lunar year began on 12 February 2021, was a painful one for investors in Chinese equities. The Ox symbolises strength and determination, traits certainly in evidence in the Chinese authorities’ single-minded approach to economic and financial management, as well as the pandemic, and its sabre-rattling towards Taiwan.

Beijing’s zero-tolerance policy on COVID-19 and its crackdown on the technology and education sectors last year, spooked investors whose nerves were already frayed by debt worries in the property sector, as symbolised by the Evergrande crisis.

“All this uncertainty contributed to a grim year for Chinese equities and unsuspecting investors who might have been lured into China funds by the spectacular gains of 2020,” says Jason Hollands, managing director at investing platform Bestinvest.

“While the MSCI China Index notched up an impressive total return of 25.7% in 2020, in 2021 it slumped –20.9%. Worse still, since the Year of the Ox began on 12 February 2021 it has tanked -34.5% (as of 27/01/2022). And Chinese ‘growth’ stocks have had a particularly brutal run with increase state interference in big tech companies: the MSCI China Growth Index is down -43.3% since the same date.

“Holders of emerging markets funds will have witnessed the impact given China is the largest country component of the index, although active managers have taken steps to reduce their exposure to Chinese equities. China represents 31.4% of the benchmark MSCI EM index (as at 31 December 2021) – down from a peak level of c.43% the year before.

“But the average Global Emerging Markets fund is underweight with 28.1% exposure, according to data provider Morningstar.”

As the Year of the Tiger dawns on 1 February, the Winter Olympics hosted in Beijing will be just days away and China will have an opportunity to present its best face to the world. Fraught international relations, however, remain a concern with the national security crackdown in Hong Kong, the ongoing threat to Taiwan’s autonomy, and treatment of ethnic groups in western China.

Ethical considerations aside, this friction with western democracies has been insignificant in the investment case compared to Beijing’s own domestic policies. Here, there is some evidence that the policy pivots of early last year to tighten regulation, crack down on certain sectors and improve wealth distribution are ‘enough for now’ as Beijing refocuses on growth.

“Another pivot is likely to be significant this year: that of the US Federal Reserve’s monetary policy,” says Hollands.

“The Fed has signalled it will start raising interest rates in March, and likely rein in quantitative easing in the coming months, to fight inflation that has proven not-so transitory, surging to 7% in December. Money market traders are pricing in more than one US rate rise this year, just as they are for the UK where rates went up in December.

“China’s monetary authorities meanwhile are cutting rates amid concerns over drags on economic growth. Analysts believe that fears around the deepening property market slump and weak consumption amid sporadic COVID-19 outbreaks will lead Beijing to further monetary easing this year. While supportive for domestic growth, this does present a currency risk with the dollar likely to appreciate significantly against the yuan / renminbi.”

Looking to what this means for private investors, a China specific fund will for most be too risky, says Hollands.

“Even those who think the ‘worst is over’ for Chinese equities and believe country-specific emerging market funds and trusts are ‘cheap’ should, because of the many risk factors, only be thinking in terms of small satellite holdings,” he adds. 

“China may be the world’s most populated country – though rival India is set to overtake it – and the second largest economy in GDP terms, but when it comes to the context of what is investible its share of world equity markets (MSCI All Country World Index) is just 3.6%, similar to the UK’s.

“The vast majority of retail investors will want to maintain exposure via broader Asian and emerging markets funds. Bestinvest top picks include Aubrey Global Emerging Markets Opportunities, which focuses on the theme of growing consumption and services in emerging markets. It has 35.4% in Chinese stocks. The growth of the emerging markets consumer is one of the most compelling long term investment themes, with Morgan Stanley last year forecasting a doubling of Chinese consumer spending by 2030 to reach $12.7 trillion – roughly the same size as the US.

“Investment trust fans night consider JP Morgan Emerging Markets, which has 30.7% China including a 5.8% in Tencent.

“For those determined to take the plunge and dive in at the deep end with a specialist China fund, the Fidelity China Special Situations trust is a strong contender. Its portfolio is currently overweight industrials, technology and healthcare stocks.”

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