The Chinese stock markets have been on fire for a few weeks now. The large price losses have also surprised local fund managers, and investors are wondering whether they can still invest in the country with peace of mind. Fund manager David Raper (photographed above) thinks these concerns are somewhat exaggerated.
Chinese stocks have had their worst month since the 2008/09 financial crisis, losing more than 10%. Some stocks have even lost dozens of percent in recent weeks, including Alibaba and Tencent. These companies in particular have been favourites of many Western investors for years, but the question is whether this will continue.
Measures are not new
David Raper, manager of the Comgest Growth Asia ex-Japan fund, is surprised by the sharp price drops and “the sudden change in market sentiment”. His fund, which had Alibaba as its biggest position (7.3% allocation) at the end of June, lost more than 10% in a month. In recent days, it has cautiously rebounded. Raper calls the market reaction largely exaggerated. He only sees the ban on commercial educational companies as a real game changer for that sector. “But most of the new measures taken by the regulator have a relatively limited impact and are more or less a repetition of earlier moves.”
Raper is referring in particular to the hard-hit sectors of real estate and internet companies such as Alibaba and Tencent. The Chinese government has been intent on stricter regulation of these two sectors for some time. “On 23 July, a government ministry published an announcement of an ‘ongoing rectification of the housing market’,” said Raper.“This suggests that additional regulation of the property market is nothing new under the sun.” After all, the Chinese Communist Party has been worried for years about a property bubble that is also making it increasingly difficult for many Chinese to find affordable housing.
Internet companies are the laughingstock because the Chinese government wants them to open up their ecosystems to competitive services from other companies. But that too is not a new development. “We do not believe that there has been a sudden and significant change in regulation, but rather that some investors have not paid enough attention to the developments of the last few years in this area,” said Raper, referring to several regulatory investigations into abuses of power by Alibaba and Tencent, among others, which have already resulted in fines for both companies.
Buying opportunities
Raper has therefore taken the opportunity to increase its positions in hard-hit companies such as Tencent. But then last Tuesday, he was suddenly confronted with an article in a Chinese state newspaper in which the addiction of many Chinese young people to Internet games was characterised in Marxist terms as opium for the people. The share price of Tencent, China’s largest gaming platform, collapsed even further.
But here too, according to Raper, there was an overreaction by investors.“This is not the first time that the ‘gaming industry’ has come under pressure from its regulators to protect underage players from themselves,” said Raper. “The best-quality players such as Netease and Tencent have shown that they can deal with this.”
Avoid policy risk
In a market commentary, Allianz GI also speaks of ‘an extreme reaction’ to developments ‘that are not really news’. But in contrast to Comgest, Allianz GI does not intend to take advantage of the price drops. On the contrary. “We are underweight on sectors with a lot of policy risk, such as internet stocks.” The asset manager prefers to focus on companies that are supported by Chinese government policy, such as manufacturers of electric cars.
The British/South African asset manager Ninety One is also not entirely reassured. “There is clearly a change in priorities at the top of the Chinese Communist Party. Therefore, investors would do well to be cautious”, says portfolio manager Alan Siow. But like Raper, he thinks the market reaction is too negative. “It is still too early to draw firm conclusions. It is too early to draw any firm conclusions as there is still too little clarity on the exact impact of the Chinese government’s recent actions.”
The unrest in Chinese stock markets has also affected the bond market. For instance, risk spreads on Chinese high-yield bonds have increased by 300 bps to 900 bps in recent weeks. The spread differential with the broad EM high-yield corporate index has also widened significantly to 400bps, well above the historical average of 150bps.
According to Aayush Sonthalia, portfolio manager Emerging Markets Debt at PGIM Fixed Income, these high spreads offer opportunities for investors. “We expect the Chinese authorities to be more responsive to market reactions and the regulator to focus its actions. Our expectation for EM high-yield corporate bond defaults is therefore unchanged at 2.5-3%,” he says in a blog https://pgimfixedincome.blog/navigating-chinas-credit-crackdown/.
Sonthalia also sees risks concentrated in the healthcare, education and residential property sectors. These companies in particular will continue to feel the effects of the new Chinese five-year plan’s emphasis on reducing inequality and boosting the sharply declining birth rate, he believes. “We therefore avoid debt from property companies with low ratings, such as Evergrande and prefer companies with good capital positions.”