Few people know that there are now more listed Chinese companies than there are U.S.-listed companies, Rebecca Jiang and Howard Wang of J.P. Morgan Asset Management say in an interview with finews.asia.
China seems to have survived the corona crisis at least economically well. Is now a good time to invest in Chinese stocks?
Howard Wang: While it’s true that China did an impressive job of controlling COVID, we would avoid trying to market time any investor’s entry point into Chinese stocks.
The simple fact is that China is evolving into one of the world’s most important capital markets – a process which we believe will continue for many years to come, and which will create opportunity along the way.
«We need good companies that will translate the economic big picture into earnings for investors»
The size of China’s economy is already well understood by the broader investing community. However economic size in and of itself isn’t a reason to invest in a country. Nor is a high economic growth rate.
Both of those factors offer potential, for sure. But what we need in order to turn that potential into financial reality is an attractive investable opportunity set: we need good companies that will translate the economic big picture into earnings for investors.
«That’s what investors need to focus on when considering Chinese stocks»
And that is where China has transformed over the past generation. China has gone from being a significant economic story with a scarcity of investable equity opportunities to being a broad, deep and vibrant capital market.
Few people know that there are now more listed Chinese companies than there are U.S.-listed companies. A growing number of those companies are the sorts of entrepreneurial, private sector businesses that we like to invest in, and we see that positive evolution continuing for years or maybe decades. That’s what investors need to focus on when considering Chinese stocks.
What are the greatest risks in the Chinese stock market for European investors?
Howard Wang: One key risk is that Chinese stocks are still volatile. This is partly due to the dominance of retail traders in the market. The short-term, momentum-driven nature of this investor base has generated significant market swings in the past, and will continue to do so
– albeit to a gradually diminishing extent as institutional shareholder penetration in China expands.
However, we would argue that the volatility which troubles some investors creates opportunities for others. For those who have the resources and time horizon to take a disciplined approach to valuation, any short-term sell-off can offer buying opportunities in favored names.
The key here is not to get distracted by emotional swings in the market, but to use rigorous analysis to look through them.
«Such actions were particularly disruptive in 2015»
Another risk is that the Chinese government has a history of intervening in markets through its regulators, with little or no consultation or notice. Such actions were particularly disruptive in 2015, for example, when the securities regulator took extreme measures to address what it perceived as excessive speculation in public equities markets.
The measures included the suspension of IPOs and secondary issues, circuit breakers triggered by extreme market movements, and trading suspensions for individual company shares, all of which froze much of the local market for six months. The impact of these measures on sentiment and market performance was profoundly negative on a global scale, and we believe the government learned from the experience.
«We believe in-depth knowledge of individual companies and management teams – rather than a passive approach»
Corporate governance in China remains another risk and is an area where experienced managers’ scrutiny and selectivity can be critical. Transparency and discipline in allocating capital also remain uneven, although these have improved over time.
For these reasons, we believe in-depth knowledge of individual companies and management teams – rather than a passive approach – will be key to success in investing in China’s domestic market.
«It’s true that there are some challenges to ESG investing in China»
In conclusion, it’s important to acknowledge some of the challenges of investing in China, in addition to the considerable attractions. The path to realizing value is by taking an approach that is fundamentally-driven, longer-term, disciplined and rigorous.
In the U.S. and Europe, more and more investors are investing sustainably – for example, based on ESG criteria. Is sustainable investing in China possible?
Rebecca Jiang: ESG considerations should be incorporated into the analysis of every single company, irrespective of which market they’re listed in. It’s true that there are some challenges to ESG investing in China – however, these are not as substantial as many people believe.
Within China, more than 50 percent of listed companies in the energy/materials/industrial sectors (especially the large-cap, leading companies) publish Corporate Social Responsibility (CSR) reports and set targets which however are more qualitative than quantitative.
«We are more comfortable with governance at private rather than at government-controlled companies»
In general, they aim to comply with the government-mandated targets rather than set ambitious internal targets; for example, MIIT (Ministry of Industry and Information Technology) sets out various environmental targets for heavy industries (like the steel and chemicals sectors) to achieve each year and over the five-year plan; airlines have carbon emission targets; express delivery companies have energy-saving targets, etc.
We are typically more comfortable with governance at private rather than at government-controlled companies. That said there is a wide range of standards within each sub-sector. This is why our own proprietary materiality framework, applied across the Emerging Market and Asia Pacific universe, is important.
«By engaging in this way we feel we’re better able to understand sustainability issues»
For this framework, we have identified 54 sub-industries, and for each sub-industry, analysts are tasked with identifying the five key sustainability issues that are relevant for companies in that industry. Companies are then scored on these issues based on the analysts’ fundamental views.
During an engagement with companies that framework helps us to focus management’s minds on what we think matters for their particular company – and as the issues vary by sub-industry this is very much a targeted approach. For example, the questions for a software business are rather different from those for an auto parts company.
By engaging in this way we feel we’re better able to understand sustainability issues at each company – and also overtime to influence change.
In the past, corporate governance in many Chinese companies, in particular, left much to be desired. Has anything changed in this regard?
Rebecca Jiang: As discussed above – the answer is case-by-case. For example, there are some Chinese listed companies that have been listed overseas that have international governance standards.
Indeed some of these received investments from international venture capital or private equity investors, who imposed international principles from the early stage (before IPOs).
«We certainly wouldn’t advocate buying all Chinese companies»
As mentioned we are less comfortable with state-owned enterprises (SOEs), which place equity investors very differently in their hierarchy of stakeholders. Broadly speaking, the average quality of Chinese businesses is lower than across emerging markets, but the depth and liquidity of the market mean we can still find a large universe of suitable investments.
We certainly wouldn’t advocate buying all Chinese companies, either on the basis of business models or of governance standards. Local expertise in the space is absolutely necessary so that we can be appropriately selective.
«Technology in China has gone beyond smartphones and e-commerce»
It is critical to have an experienced team of Mandarin-speaking investment professionals to analyze alternative sources of data (e.g. supply chain/channel checks, competitors and industry experts) to assess management quality, business conditions, etc.
Which industries are the most attractive in China with a view to the next five years?
Rebecca Jiang: We focus on secular growth when investing in China. Key potential growth opportunities are emerging in the technology, healthcare and consumer sectors. Many elements of these structural growth trends have been underpinned and accelerated by the pandemic.
Technology in China has gone beyond smartphones and e-commerce. Artificial intelligence and cloud computing are becoming a part of everyday life.
Amid geopolitical uncertainty and facing some decoupling risk with the US, China’s technology industry is embracing an inward economic pivot, and looking to make breakthroughs in core technologies to reduce its reliance on imported software and hardware.
«China’s healthcare industry covers a considerable number of sectors»
Another structural change that was evident before the crisis, but whose importance has been reinforced by it, is increased demand for healthcare services and products, including healthcare infrastructure, preventive treatment and vaccine development.
China’s healthcare industry covers a considerable number of sectors, and spending on such services could continue to grow. We find attractive investment opportunities in areas like pharmaceutical R&D, R&D outsourcing, and medical equipment manufacturing.
«Minority equity investors are not at the top of their list of stakeholders»
Lastly, as household income increases and the standard of living improves in China, its middle class is increasingly focused on lifestyle upgrades in both daily necessities and entertainment. Alongside supportive domestic policies, consumption is expected to become a key driver of economic growth.
How does the banking sector look to a potential investor? Does it have a price potential?
Rebecca Jiang: The banking sector is not one of our favored areas of the market in China. The largest banks are state-owned, and minority equity investors are not at the top of their list of stakeholders.
«This is not to say that we find no opportunities in the banking sector»
For example at the outset of the pandemic, banks came under pressure to conduct «national service», supporting the broader economy via lower interest rates for small and medium-sized enterprise (SME) loans and relaxing repayment requirements. This positive impetus for borrowers came at the expense of returns to equity investors. Conversely, private sector corporates tended to meet with less interference.
This is not to say that we find no opportunities in the banking sector. China Merchants Bank is a leading bank on profitability, with a strong retail franchise and increasingly robust pricing power following deeper penetration into micro and SME lending.
«We also like other areas of financials such as insurance»
While the bank is still controlled by the government, it has been encouraged by the state to run commercially since its establishment. Ping An Bank is another mid-sized bank, with an impressive technological edge.
We also like other areas of financials such as insurance – e.g. Ping An Insurance – where penetration rates remain low, as a result of which we see long growth runways. In aggregate, however, we remain underweight financials in favor of New Economy areas of the market where we see more attractive opportunities.
Rebecca Jian is a co-Portfolio Manager for China and China A-shares funds in the Emerging Markets and Asia Pacific (EMAP) Equities team at J.P. Morgan Asset Management. Based in Hong Kong, she joined the firm in 2017 after six years at Fidelity International. She began her career with Deutsche Bank in 2005 as an Equity Research Analyst. She obtained a B.A. in International Finance and a Masters in Finance from Fudan University.
Howard Wang is a co-Portfolio Manager for China and China A-shares funds in the Emerging Markets and Asia Pacific (EMAP) Equities team at J.P. Morgan Asset Management. Based in Hong Kong, he leads the Greater China-dedicated investment teams in Hong Kong, Shanghai and Taipei. He joined the firm in 2005 after eight years at Goldman Sachs. He began his career with Lazard Frères in 1995 in New York. Howard obtained a B.A. summa cum laude in economics from Yale University.
