Will China bring prosperity to investors in the Year of the Rabbit?

interactive investor’s experts assess whether this Lunar New Year marks the return to more positive investment sentiment towards China.

The Chinese New Year falls on 22 January this year, and 2023 is the Year of the Rabbit. The rabbit is the symbol of longevity, peace, and prosperity in Chinese culture, thus 2023 is predicted to be a year of hope.

Investing in the Chinese market has been an uphill battle over the past year. It was a disappointing year for the Chinese market, hampered by the government crackdown on the nation’s tech giants, geopolitical tensions, rising inflation and interest rates and, not least, it’s attempts to maintain its zero-Covid policy, which has only recently begun to ease.

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Although, perhaps much of the expected bad news for China has now been priced in by markets. For example, despite another new wave of infections following the country’s re-opening, markets, which are forward-looking, have not been rocked like they have been previously. Travel restrictions in and outside the country have now been lifted, and as part of the new year celebrations, travel will be key in boosting China’s own economy.

interactive investor’s experts assess whether this Lunar New Year marks the return to more positive investment sentiment towards China.

The outlook for Chinese equities

Victoria Scholar, Head of Investment, interactive investor, explains: “Chinese equities have started the year with a bang. The Hang Seng and the Shanghai Composite have staged strong gains so far in 2023, ahead of the Chinese New Year.

“On the one hand, its hotly anticipated economic reopening with the long overdue dismantling of Beijing’s zero-tolerance to Covid lockdown measures could finally release a surge of pent-up demand. On the other hand, the world’s second-largest economy is grappling with a spike in infections, which is likely to test the resolve of the Chinese authorities to stick to their reopening trajectory. China is also dealing with the problem of low vaccination rates, particularly among the elderly, and there is also a lack of official data available on the seriousness of its Covid outbreaks.

“The MSCI China index has surged by 50% off the lows in November, when signs emerged that it was finally set to reopen its borders and the year-end rally has extended into 2023. Attention is finally starting to turn back to China once again as a country with significant investment potential. However, caution remains, with potential headwinds from the possible reimposition of Covid restrictions, strict regulation from Beijing especially in the tech sector, and the overhang from its property crisis.”

“The MSCI China index, which measures large and mid-cap representation across China securities listed on the Shanghai and Shenzhen exchanges, was down 21% last year, and has started 2022 with a whimper – down 0.72% (to 25 January*). Geopolitical tensions, the Covid pandemic, rising interest rates, and inflation, are among a number of factors which have taken a bite out of market performance.”

Adding to this, Kyle Caldwell, Collectives Editor, interactive investor, notes a few considerations that may be on investors' ‘worry list.’ He says: “It’s important to consider the debt levels in China’s property market, and policy tightening and stringent regulation by China’s government in a number of sectors, notably technology and property. Another big concern going forward, which has led some fund managers to completely sell out of China, is that further regulatory crackdowns could be made in the future that will stifle the growth of successful companies – potentially limiting their share price upside.

“However, the counter argument is that the political risk of investing in China is nothing new, and that it is a price worth paying.”

Accessing China from an investment perspective

Dzmitry Lipski, Head of Fund Research, interactive investor, says: “As the Chinese economy continues to mature and become more open, government policy changes and the resultant volatility should be no surprise and short term sell-offs can create buying opportunities for long-term investors.

“The long-term case for investing in the China growth story remains intact. Growth of the middle class and the refocusing of China's economy towards domestic consumption are expected to be key drivers of economic growth and the stock market in coming years. As China is increasingly recognised as being a major driver of global growth, investors should consider having exposure to China when building a balanced portfolio. China currently represents nearly 18% of world GDP but only 5% of world market capitalisation.”

Lipski adds: “There is, of course, a personal decision that investors – and even professional managers – need to take when looking at China from a governance (or broader ESG) perspective. Ultimately, there are no easy answers when it comes to investing in China, but it’s a hard region to avoid, whether it comes to investing, or through our everyday lives, from technology and beyond. Investors need to tread carefully, but a good way to get exposure to the region is through a fund or investment trust.”

Fund and trust examples

Lipski highlights some fund and trust examples for investors seeking exposure to China. He says: “Fidelity China Special Situations (LSE:FCSS)provides broad, diversified exposure to Chinese equities, including 'H' shares listed in Hong Kong and mainland-listed 'A' shares. It has been managed by Dale Nicholls since April 2014. He focuses on faster-growing, consumer oriented companies with robust cash flows and capable management teams. Due to the trust's single country exposure, its bias to small and mid-sized companies and its ability to use gearing, its return profile is likely to be more volatile, making it higher-risk and a satellite (adventurous) holding in a well-diversified portfolio.

“Alternatively, investors could also consider a broader Emerging Markets or Asian fund from the Super 60 such as Fidelity Asiaor the TB Guinness Asian Equity Income.”

Kyle Caldwell, Collectives Specialist, interactive investor, adds: “For retail investors, as China is the world’s second-largest economy and home to some of the world’s most-exciting entrepreneurial businesses, it is difficult for investors to neglect in their portfolio, despite its political risks.

“Most global funds and investment trusts only have a small amount of exposure to China or none at all – instead preferring to stick mainly to developed markets. However, for Scottish Mortgage (LSE:SMT), a member of interactive investor’s Super 60, a long-running theme has been its holdings in Chinese internet stocks, such as Tencent (SEHK:700) and Alibaba (NYSE:BABA). These firms have dented performance in the past couple of years, as Chinese lockdowns and a crackdown from the government on tech profits have hurt investor sentiment.

“However, Scottish Mortgage’s near 10% allocation to China may turn out to be an advantage this year. Although this is provided that the trust does not continue to reduce its exposure to Chinese shares. Two years ago, the trust had more than 20% in China shares. In 2022, it moved to reduce exposure amid concerns over regulatory risk following intervention in markets and the economy from China’s communist government.

“Emerging market funds and investment trust tend to have more of their money in China. One example is JPMorgan Emerging Markets (LSE:JMG), another member of interactive investor’s Super 60, which holds just over a fifth of its portfolio in China. Tencent is the portfolio’s third-biggest holding.

“However, it is worth remembering this is an adventurous investment, and that it should be viewed as a satellite holding as part of a diversified portfolio.”