By Sunny Bangia, portfolio manager of the Antipodes Asia Fund
Changes in the regulatory environment have increased uncertainty and it may take time for this to dissipate. The question is, what is the ‘end game’ of tightening regulation? Are policy makers threatened by a growing private sector?
The purpose of tighter regulation around Ant Financial and other financial holding companies is to ensure fintech platforms which act as originators of loans provide adequate balance sheet collateral – ’skin in the game’ ensures sensible lending practises.
The essence of anti-competitive regulation is to ensure the large ecommerce platforms do not benefit at the expense of the consumer. It’s to prevent restricting suppliers to exclusive deals, using technology (algorithms, data/traffic throttling) against competitors, and restricting differentiated pricing / conditions between customers. Regulating private tuition is arguably to shift the cultural focus away from overly aggressive tuition, which is not ideal for social stability.
There is no question the Chinese regulators have acted in a blunt fashion, and there have been implications for over-reaching Chinese entrepreneurs. But investors must ask themselves, are these policies unreasonable? Is it unusual for regulators globally to regulate lenders, protect consumers from anti-monopolistic behaviour or have concerns around data security?
The bigger picture
China has 60% share of all patent applications globally. Only 5% of these come from state-owned enterprises. The rest come from China’s private sector or western companies originating their IP in China.
China understands its economic growth is dependent on a vibrant private sector. The high-profile internet businesses are an essential part of this, providing solutions to the everyday lives of consumers. The margin of safety to invest in China has risen. Investing in emerging markets anywhere in the world requires a higher margin of safety, and investors need to be selective about what they own.
Chinese equities are currently valued at a 35% discount to US equities, a valuation discount which has only been exceeded as the Asian crisis unfolded in the late nineties. Greater regulatory and geopolitical risks are arguably factored in.
We are constructive on internet businesses that benefit consumers like increasing e-commerce penetration in lower tier cities and modernisation of the fresh food channel, and in digital advertising given the size of the opportunity. We have always assumed Chinese online platform companies under-monetise by up to 50% relative to developed world counterparts, and this discount will likely persist.
When we stress test our holdings, we find they are all in good shape to manage the regulatory backdrop. Further, Facebook shows that heightened regulatory concerns, all else equal, can be good buying opportunities and can allow incumbent companies to build higher barriers to entry.
Markets often react irrationally to fear. Investors can’t ignore risk, but they shouldn’t be blinded by it when investing for the long term.