Is it time to hold your nose and invest in China?

On the surface, there are so many ‘moral’ reasons NOT to invest in China . For example, draconian new security laws in Hong Kong; human rights abuses against the Uighurs in the region of Xinjiang; Beijing’s sabre rattling against Taiwan; and the country’s continued militarisation of the South China Sea. And, of course, its lack of transparency over the coronavirus outbreak in Wuhan that triggered the global pandemic and widespread economic destruction. 

Yet, talk to most professional investors – a representative cross-section of whom I spoke to last week – and they dismiss these moral arguments with gusto. Indeed, they accuse China naysayers as hypocrites, happy to criticise China in one breath but then conveniently overlook some of the questionable activities that go on in the West. 

More compellingly from an investment point of view, they argue that the naysayers will continue to miss out on the bounty of opportunities that the Chinese equity market offers UK investors. Opportunities that will not go away as President Xi Jinping ruthlessly executes his strategy of making China the world’s largest economy by 2049, the 100th anniversary of the country’s communist revolution. 

Food for thought: China showed a lack of transparency over the coronavirus outbreak in Wuhan that triggered the global pandemic and widespread economic destruction

David Coombs is head of multi-assets at investment house Rathbones, a job that involves deciding what stock markets and assets will provide investors with the best returns in the future. Although he admits being uncomfortable about some ‘issues’ surrounding China, he believes that ‘balance’ is important in any debate about the country. 

‘In the West, we forget that our governments have – and continue to be – engaged in activities that are questionable from a moral standpoint,’ he says. ‘But when you talk to Chinese people, you receive a different perspective of everyday life in China. One member of my team is from China and her insights have supported a more thoughtful view, one that is not so flat or one-dimensional. For me, China is a developed market and its equity and bond markets should form a greater part of world indices and by implication investors’ portfolios.’

Rathbone Strategic Growth, a £1 billion fund that Coombs runs, has 2.5 per cent of its assets invested in China although he says this exposure is expected to increase over the next couple of years. 

Brian Dennehy, managing director of FundExpert, is more forthright in his opinions. Just before coronavirus became a global rather than just a Chinese problem, he told investors to ’embrace the Year of the Rat’. 

He has been vindicated – with some funds available to UK investors (such as Fidelity China Special Situations, Baillie Gifford China and JPMorgan China Growth & Income) generating returns for shareholders in excess of 50 per cent, year to date. 

‘Morality is not the crucial issue when it comes to investing in China,’ says Dennehy. ‘If it was, we certainly wouldn’t be investing in the US, nor a few European nations. 

‘When did China last lie and cheat to justify invading nations thousands of miles away, resulting in the deaths of tens of thousands of innocent civilians? The fact is, we need to push our xenophobia to one side, accept this is Asia’s century, and embrace it. The economic case for China remains strong and we continue to be positive about the stock market despite the fact there will always be some extreme volatility along the way.’ 

THE GROWTH OF THE CHINESE CONSUMER 

China is no longer the manufacturing hub of the world, pumping out cheap products for the Western world to consume. 

Rising labour costs and the worldwide employment of artificial intelligence and robotics across swathes of industry have triggered a major change in the economy’s direction – nudged by trade wars with the United States and other countries such as Australia. 

As a result, it is now Chinese consumers – rather than their Western counterparts – that the economy is focused on serving and it is the emergence of this free-spending middle class that excites many investment experts. 

In the first half of this year, consumption accounted for around 60 per cent of the country’s growth in gross domestic product. 

Ben Yearsley is a director of Plymouth-based investment adviser Shore Financial Planning. He says: ‘The reason you can’t dismiss China is because of its burgeoning middle class and the entrepreneurial nature of the economy – despite the communist leadership. With a lot of Western brands banned, it gives Chinese companies free access to 1.3billion people. The middle class want to buy things – and they now have the money to do it.’ It’s a view shared by others. Dzmitry Lipski, head of fund research at wealth manager Interactive Investor, says the rise of the Chinese consumer is ‘a huge growth theme that is still very much intact’. As a result, he believes that avoiding China ‘could potentially be costly for long-term investors’. 

Darius McDermott, managing director of investment scrutineer FundCalibre, is also excited by the consumer story. ‘The Chinese economy is still transforming, but it is in its second phase of consumerism,’ he says. ‘The first phase was when people started getting money and buying items such as white goods. The second involves the buying of big brands and higher priced items. It’s also leapfrogged some trends previously established in the West – so few landlines and straight to mobile phones, and the early adoption of electric vehicles.’ 

The importance of the Chinese consumer is reflected in the portfolio of Fidelity China Special Situations, a £2.5billion investment trust managed from Hong Kong by Dale Nicholls. About 45 per cent of the trust’s assets are invested in businesses with a focus on supplying ‘consumer discretionary’ goods and services – everything from cars to mobile phones. 

Nicholls believes there is ‘considerable opportunity in the supply of consumer goods to Chinese households, especially when viewed relative to homes in other countries’. 

Speaking from Hong Kong last week, he said the underlying investment case for China is strongly founded on ‘the development of the middle class’ – a process supported by a government determined to build an economy focused on consumption.

Among the portfolio’s more recent success stories are Yadea Group Holdings, the largest e-bike manufacturer in China, and China MeiDong Auto Holdings that focuses on selling luxury car brands such as Porsche and BMW. 

Nicholls says the opportunities for fund managers to find suitable Chinese companies to invest in have never been greater – due to a significant growth in companies being formed and coming to the market. 

As a result, the trust’s portfolio has around 130 to 140 holdings with an emphasis on small to medium-sized businesses. It also has a 6 per cent exposure to unquoted stocks – the likes of logistics company Full Truck Alliance and autonomous vehicle technology company Pony.ai. ‘There are lots of companies in China that are off the beaten track from an investment point of view,’ says Nicholls. ‘But some will become the medium and large companies of tomorrow. It’s these businesses we are interested in.’ 

However, Jason Hollands, a director of wealth manager Tilney, is not a big fan of China. He believes the country faces major economic and social challenges as it supports an increasingly ageing population – problems fuelled by the now abandoned ‘one child’ policy.

But he reckons the country’s rapid urbanisation, accompanied by a growing and aspirational middle class, is fuelling the ‘rapid growth of the Chinese consumer’. ‘An investment fund we back that really plays into this theme,’ he adds, ‘is Aubrey Global Emerging Market Opportunities. 

‘It is managed out of Edinburgh, 59 per cent invested in China and has big exposure to the country’s consumer stocks.’ 

Key holdings include meal delivery firm Meituan, sportswear giant Li Ning and New Oriental Education, the country’s leading after school tutoring provider. 

CHINA HAS ITS OWN TECHNOLOGY GIANTS 

Most investors associate ‘technology’ with big US companies such as Alphabet, Amazon, Apple and Facebook. But China has also allowed technology giants, including Tencent and Alibaba, to prosper and become ‘domestic champions’. 

Despite Nicholls’ focus on small to mid-sized companies, the two companies represent by far the biggest holdings in Fidelity China Special Situations – at 13.9 per and 15.1 per cent respectively. ‘They’re great companies,’ he says. ‘They are key components of China’s economy.’ 

It’s a view shared by Robin Geffen, manager of investment fund Liontrust Global Technology. 

He says: ‘Tencent has some extraordinary components to its business, including WeChat, a multi-purpose social media, messaging and mobile payment app. Released in 2011, it became the world’s largest standalone app in 2018. Alibaba, China’s largest online commerce company, has hundreds of millions of users and hosts millions of merchants and businesses. Its advertising revenues are comparable to those of Amazon.’

This post first appeared on Dailymail.co.uk