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China: An Under-researched Market

Jian Shi Cortesi, who has been managing a consumer-focused China equity strategy for more than three years, provides an overview of the prevailing stock-picking environment.

Thursday, April 13, 2017

The Chinese stock market has experienced a number of rotations in recent years, which places great emphasis on stock selection as a performance driver for specialist equity funds focusing on China. In our view, the frequency of rotations is an inevitable by-product of an economy that is in the process of a transition from being export driven towards one in which the consumer becomes the major contributor.

Consequently, we believe the best places to invest in China are consumer sectors, as well as technology, healthcare and financial services. In picking stocks in these areas, we rely on in-depth knowledge of the local markets. Among the stocks we have held, a number of favoured holdings in the consumer sectors (discretionary & staples) have proved particularly lucrative, including automobiles, food & beverage, travel and insurance as well as technology-related areas like internet and ecommerce.

It is important to be nimble

In general, the stock-picking environment in China tends to be difficult because market trends change faster than in many developed markets. Consequently, we continuously look for new opportunities and are aware of the importance of being nimble. However, we also have an advantage as China is a relatively inefficient and under-researched market. This makes the task of finding and exploiting valuation anomalies easier than in major developed markets. In uncovering such opportunities, it is essential to be able to access a good network of people on the ground, whose collective knowledge and insights act as valuable inputs in our stock selection process.

From a thematic perspective, we are particularly interested in the following developments: 1) the continuous expansion of e-commerce and mobile games; 2) growing demand for SUVs and improvement in local brands in the auto market; 3) the recovery of jewellery and luxury spending; 4) secular growth in education, tourism, healthcare and financial services. This reflects a growing sophistication among Chinese consumers who, while continuing to be attracted to the accumulation of possessions, are increasingly valuing the concept of ‘consuming’ an experience.

We are also aware that Chinese consumers are deeply-swayed by history and tradition when purchasing products. This is important because there are a select few businesses in China with roots dating back centuries, which are regarded with great esteem. Such companies typically benefit from extremely attractive profit margins and a virtually impregnable brand positioning, by virtue of their firmly established stronghold.

Like most non-mainland China funds, we primarily invest in Chinese shares listed in Hong Kong as well as Chinese stocks listed in the U.S. The Shenzhen-Hong Kong Stock Connect Programme, together with the earlier Shanghai-Hong Kong Connect, has opened up many domestically-listed A-shares to overseas investors. This has provided us with greater flexibility in terms of stock picking and, since the Stock Connect Programmes were launched, we have added positions in Chinese A-shares, although our overall exposure remains low. We are extremely selective when it comes to picking Chinese A-shares. Shenzhen-listed stocks are trading at much higher valuations than in Hong Kong, so we are only interested in large Shenzhen-listed companies with good growth prospects and reasonable valuations.

For many, investing in Chinese stocks can be a perplexing endeavour. First of all, Chinese equities include domestic A-shares traded in the yuan, Hong Kong-listed Chinese stocks traded in the Hong Kong dollar, and Chinese stocks listed in the U.S. Each of the three market segments has its unique dynamics and can behave very differently from one another. In addition, Chinese equity markets are influenced by global investor sentiment, which makes it very difficult to predict short-term market movements.

In terms of stock picking, investing in China is a fierce landscape if one lacks the correct expertise, the knowledge of China’s unique culture, or even the necessary language skills. Due to these reasons, investors need to tread carefully in respect of Chinese equities, particularly the domestic A-share markets, where international investor participation remains low, despite the ‘Connect’ programmes. Nevertheless, we believe that, if access is gained via an experienced professional well-equipped in dealing with the nuances of the Chinese market, investing here is worth the effort and significant rewards can be reaped.

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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.