In the years leading up to 2020, Chinese equities enjoyed an unparalleled surge in dominance within emerging markets, at one point accounting for nearly 40 percent of the emerging market index. However, the advent of the coronavirus pandemic, government crackdowns on the tech sector, the implosion of the real estate bubble, and a slowdown in economic growth have collectively taken their toll on the stock market. As a result, China’s share of the index has now almost halved.
China has long held a prominent position in the realm of emerging market investments, and this is hardly surprising. For years, the nation has epitomised the rapid growth and development that emerging markets aspire to achieve. With a weighting of more than 23 percent, China remains a heavyweight in emerging market indices, such as the Morningstar EM TME index. This positions it just ahead of India and Taiwan, which constitute nearly 22 percent and 19 percent of the index, respectively.
Yet, the significance of Chinese equities was even more pronounced just a few years ago. At the close of 2020, China’s weighting in the emerging market index still stood at 40 percent, a figure that matched the combined weight of India, Taiwan, South Korea, and Brazil. This increase was driven partly by index compilers who, between 2017 and 2019, began to incorporate more so-called A-shares into the index. Previously, investors primarily relied on H-shares traded on the Hong Kong Stock Exchange, but over time, access to stocks listed on mainland Chinese exchanges—such as those in Shanghai and Shenzhen, quoted in Renminbi—broadened.
Dominance has shifted
Chinese equities’ stellar performance also significantly contributed to the country’s increased dominance within emerging market indices. Between 2013 and 2020, the Morningstar China TME index lagged behind the Morningstar EM TME index in only two calendar years. Over this period, Chinese equities outperformed other emerging markets by five percentage points per year.
The turning point came with the coronavirus pandemic, although 2020 still stands out as the best year for Chinese equities, delivering a return of 19 percent. While not the highest absolute return, it represented a strong outperformance relative to the emerging markets index (8 percent) and the Morningstar Global TME index (6 percent).
However, the protracted and stringent lockdowns during the pandemic eventually took a heavy toll on the Chinese economy. Though the economy grew by 2.24 percent in 2020, this was a far cry from the over 5 percent growth seen in previous years. The years of robust, above-average growth now seem a distant memory, exacerbated by the bursting of the real estate bubble. The real estate sector had long been a key driver of China’s vibrant economic growth, but the downturn proved unsustainable, with overindebtedness leading to the collapse of several major developers, Evergrande being the most infamous example.
Dampened consumer spending
Economic uncertainty has significantly dampened consumer spending, and the government has struggled to reignite it, even after the end of lockdowns. Furthermore, a series of new laws and regulations, particularly targeting the technology sector, have made investors wary. Notably, the government’s restriction limiting children to three hours of gaming per week has hit the sector hard, with leading companies such as Tencent, Alibaba, NetEase, and Baidu seeing their share prices suffer significantly.
Since 2020, Chinese equities have underperformed against both emerging and developed markets every year. As of the end of July 2024, Chinese equities have posted a year-on-year loss of 11 percent, while emerging markets have managed a 2 percent gain and global equities have recorded an increase of over 12 percent.
Interestingly, investors remained optimistic about China’s stock market for a considerable period following the onset of the pandemic. From 2020 to 2022, over 19 billion euro of new investor capital flowed into Chinese equity funds sold in Europe. However, this trend reversed after the first quarter of 2023, with these funds collectively registering outflows of 7.5 billion euro.
FSSA China Growth fund
The strategies that feature prominently on Morningstar’s radar either boast a solid management team and investment process, as judged by fund analysts, or are rated highly based on an algorithmic evaluation using the same criteria. In this edition, we highlight a fund that meets all these criteria. The FSSA China Growth fund has received the highest possible rating—’High’—from Morningstar’s analysts for both the People and Process Pillars, resulting in a Morningstar Medalist Rating of Gold.
A key factor underpinning the strong conviction in this strategy is the presence of lead manager Martin Lau. With nearly three decades of experience investing in China, Lau has been at the helm of this fund since 2002. He is a passionate investor with a proven track record of delivering exceptional long-term returns. He leads a team of 22 investment professionals, who collectively average 13 years of investment experience, seven of which have been spent at the firm. The team adopts a generalist approach to research, with approximately 50 percent of their time dedicated to analysing Chinese equities, despite their broader responsibilities in following Asian markets.
Lau employs a time-tested approach focused on high-quality companies that demonstrate sustainable and predictable growth, with shares trading at reasonable valuations. The team places great importance on the quality of a company’s management in identifying such opportunities, while also scrutinising the business model and balance sheet strength. Lau’s investment strategy prioritises absolute performance over relative performance against benchmarks and industry peers.
As a result, the portfolio construction is entirely bottom-up, leading to significant variations in sector exposure. For example, as of the end of June 2024, the portfolio was heavily overweight in healthcare and industrial stocks, while consumer cyclicals and financial services were notably underweight.
Ronald van Genderen is senior manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners. This article originally appeared in Dutch on InvestmentOfficer.nl.