Why some pros have completely sold out of China
15th September 2022 10:55
by Sam Benstead from interactive investor
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Political interference in financial markets as well as economic troubles are pushing some global investors to sell their Chinese shares.
Once the hottest emerging market every investor wanted a piece of, China is being shunned by more and more investors as the Communist party intervenes in markets and its economy becomes more fragile.
The problems for Chinese companies, particularly those in the technology sector, began in 2020 when the initial public offering of Alibaba-backed Ant Financial was scrapped. There have since been fines for anti-competitive practice for its giant technology platforms, and key executives replaced with Communist party allies.
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Economic problems are also building, such as a declining population – forecast to halve by 2050 – as well as an overheating housing market.
Jason Pidcock, manager of the £950 million Jupiter Asian Income fund, having been underweight Chinese shares versus the 28% allocation in its benchmark, now holds no mainland Chinese stocks.
In July, he sold its last remaining Chinese stocks, as well as one Macau-based business. He said: “Prior to this, the fund had already been underweight China for some time, due to my low expectations of corporate profitability relative to the rest of the region and a belief that valuations in China deserved to be de-rated, given a long period of regulatory clampdowns and travel restrictions.
“More recently, I have become increasingly uncomfortable with the direction of domestic politics in China, as well as the souring of relations with other countries, in particular the US, and I continue to take a negative stance on the outlook for China’s economy.”
Pidcock adds that there could be more investment restrictions to come, and heavy interference by the Chinese government in the economy is having an impact on growth.
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He said: “There have been widespread reports of mortgage holders boycotting payments due on unfinished homes and the property sector is weighed down by very heavy debts. Indeed, a number of developers have already defaulted on loans.
“In order to ease the situation, there has been some heavy-handed government-directed bank lending – this is something we do not expect to see in well-functioning economies. The continued zero-tolerance Covid restrictions are straining the economy further, and GDP growth is likely to be low this year and next. It is even possible that a deflationary period could begin in the year ahead if China’s banks recognise a higher proportion of the bad loans on their books.”
Pidcock prefers to own Asian companies that have indirect exposure to China. His fund owns Samsung and Taiwan Semiconductor Manufacturing Company, for example.
He said: “Our preference is to keep this exposure indirect via businesses in neighbouring countries that successfully sell goods or services to China. There are many companies across Australia, India, Singapore, South Korea and Taiwan that we remain happy to invest in.”
Economic troubles
Simon Edelsten, manager of the £460 million Mid Wynd International investment trust, takes a similar view. He sold out of all Chinese stocks last summer.
Speaking to interactive investor in a video interview, Edelsten said: “At one stage we had nearly 10% of the trust's assets in China, so it was a significant proportion of our assets going back three or four years now – and we'd made very, very good money there.
“But we were wary that the Chinese government, having done a remarkable job for their people over 20 years bringing up the average per capita pay, now has a very different set of political priorities than creating manufacturing jobs.”
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Another problem, he notes, is that Chinese society is ageing rapidly, with few people going into the workforce because of the one-child policy from 1980 to 2016.
Edelsten said: “There is dependency ratio issue: fewer people working and more people to be looked after because of how quickly the population is ageing.”
He also argues that political China is in a tough place at the moment, caught in a dispute with America on trade and “a friend” of Vladimir Putin in Russia.
“It’s caught in a very difficult place, and we, as Western shareholders, are therefore caught in a difficult place, so we continue to be better safe than sorry on that at the moment,” he said.
Scottish Mortgage still likes China
But not all global investors have turned their back on China. Scottish Mortgage, the giant trust from Edinburgh-based Baillie Gifford, has around 15% invested in China. That figure was as high as 23% in 2020, but shares fallen significantly in value since then.
This is compared with 3.5% invested in the MSCI All-country World Index and 2% for the typical global open-ended fund and 3.5% for the typical global investment trust, according to financial data firm Morningstar.
Managers Tom Slater and Lawrence Burns believe that the innovation from Chinese companies, as well as the size of the domestic market, means owning Chinese shares makes sense regardless of the political and economic challenges.
Writing in the latest annual report for Scottish Mortgage, Slater and Lawrence said: “China’s economy is now approximately three-quarters of the size of the United States, and even larger when measured using purchasing power parity, and a multiple of any other country.
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“Its technology companies are world-leading in some important areas. The ‘Made in China 2025’ plan aims to make good its shortcomings in others. Indeed, by denying access to American technology, the US government forces previously ambivalent Chinese corporates to develop domestic supply chains.”
They recognise the problems for the private sector, but have so far stuck with their investments. Slater and Lawrence say: “Investors in Chinese companies have suffered from President Xi’s regulatory crackdowns in the name of ‘common prosperity’.
“In retrospect, it has been a mistake to reduce our holdings in western online platform companies rather than their Chinese counterparts. The censure of Ant Group at the time of its proposed stock market listing turned out to be the first in a slew of actions that included severe constraints on the online tutoring sector, restrictions on video games, anti-monopoly activities against internet platforms and new policies on data and privacy.
“Many of the actions in isolation are similar to reforms that have been considered but less successfully implemented elsewhere. In aggregate, they add up to a substantial reinforcement of government control of the private sector.”
However, they are sticking with China, even though they recognise that there may be a limit to how high stocks can go, and they need to be wary of sanctions.
They said: “Our Chinese holdings have remained largely unchanged through this period of turbulence.”
Chinese shares, as measured by the MSCI China index, have fallen 18.5% over the past 12-months, 8% over three years and 3% over five years. The index has doubled over 10 years, however.
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