With today being Chinese New Year, Tom Kynge, Portfolio Manager, multi-asset at Sarasin & Partners, examines the current state of Chinese equities. He explores why the headwinds have affected valuations, along with highlighting where opportunities may be emerging, and how investors can navigate the market by aligning with long-term state priorities.
“China is complex because, on the one hand, you have incredible companies and technological innovation taking place. On the other hand, the policy environment can sometimes create uncertainty for investors, as it is not always a capital-markets-first environment. However, when you look at the level of innovation happening in China relative to the valuations placed on some of these companies, there are opportunities where the market may not be giving fair attention to businesses exposed to attractive end markets with strong structural growth characteristics.
“For example, humanoid robots are likely to become a major theme over the next decade, and many of the world’s leading companies with exposure to humanoid robotics are Chinese. At the moment, many of these businesses are overlooked by global investors due to geopolitical and governance concerns.
“In geopolitical terms, the escalating tensions between the US and China has been running since at least 2016 during Donald Trump’s first term (arguably tensions were rising ahead of his election). In addition to the harm caused by protectionist trade policies, such as tariffs, there is also capital market retrenchment. Many US money managers are reluctant to invest in a country that is perceived to be a strategic competitor to the US. A good example of this is BlackRock’s closure of its China Flexible Equity Fund after pressure from US legislators. Removal of US liquidity has proved a headwind to Chinese equity valuations.
“State interference is another significant concern for investors. Chinese state policy has, at times, imposed significant losses on shareholders when the objectives of the company conflict with the objectives of the CCP. Good examples of this include the Three Red Lines policy targeting real estate developers, the post-pandemic regulatory tightening of large technology platforms, and the overnight censure of private tutoring companies in 2021. Such investment risks necessarily increase the required risk premium and, therefore, depress valuations.
“Reconciling the opportunity with the associated risks, the best method of investing in Chinese equity markets is to invest in companies where the interests of the company shareholders are aligned with the interests of the CCP. This is most clearly the case for companies that are leaders in key technological frontiers, as China seeks to establish itself as a global technology leader capable of rivalling US capability. Examples include electric vehicles, solar panels, AI model training, and potentially humanoid robotics.
“Some of these end markets experience consistent price deflation; however, parts of the supply chain can prove attractive investments when they produce high-quality components or systems that capture healthy margins while maintaining global cost competitiveness. Our research is therefore focused on identifying companies with technological differentiation, pricing power within their niche, and alignment with long-term policy direction.”
