Emerging markets: Where the China opportunities lie
Opportunity in China is not always where you might think. Global Emerging Markets Opportunities portfolio managers James Syme and Paul Wimborne (pictured above) explain their approach
THIS month we highlight one of the main expected drivers of our portfolio and explain the case for those investments.
We focus on these holdings because a high-level look at the portfolio’s relative weightings might not bring out the degree of our conviction.
At a country-level, our portfolio is broadly neutral China — a country that represented 42.6% of the MSCI Emerging Markets Index at the end of August.
There are different groups of stocks within that Chinese index weight — including Hong Kong-listed securities (23.4%), mainland China-listed securities (5.1%) and US-listed securities (14.1%).
The US group is mainly technology and new consumer companies that have generally participated in the broad rally in US equity markets.
Although it is Hong Kong-listed, Chinese alcohol producer Meituan Dianping (1.8% of the MSCI EM Index) can also be thought of as one of the Chinese consumer stocks that have re-rated this year.
In total, this group constitutes 15.9% of the MSCI Emerging Markets Index.
Where we focus
The Global Emerging Markets Opportunities portfolio has a zero weight in these names.
Instead, it has a substantial allocation to companies that are beneficiaries of a policy-led recovery in domestic economic activity in China.
Recent economic data points to a fairly strong Chinese economy (certainly compared with other major economies).
The data also shows the recovery is driven (as in previous recoveries in 2009-10, 2013 and 2015-16 — by centrally-mandated liquidity and credit provision; and the feed-through of that into construction, real estate and financial sectors.
Although there is some positive effect on Chinese consumers, we do not see signs of a strong recovery.
We do not share the consensus enthusiasm for expensive Chinese consumer stocks.
The heartbeats of Chinese policy are credit growth and money supply growth.
Having been restrained back to single-digit growth rates for the last few years, the period since March has seen a marked pick-up in both.
In the year to July we’ve seen M2 growth of 10.7% (year-on-year) and growth in claims on the financial sector of 12.4%.
While still below the 2016 peaks of 14% and 22.2% for example, there has clearly been a step-change in policy in China.
This has driven a pick-up in the Chinese economy.
Composite PMI measures for August are around the 55 level, industrial profits in the year to July are up 19.6% year-on-year and property and infrastructure investments are showing clear recoveries.
GDP growth in 2Q20 was 3.2% year-on-year. This was a substantial positive surprise relative to expectations.
Signs of strength
Other signs of strength can be seen at a micro level — for example a sharp move higher in Chinese copper imports since June.
Then there are the positive year-to-date returns from mainland Chinese equities and strong growth in southbound mainland-to-Hong Kong equity investment flows.
By comparison, retail sales in the year to July were down 1.1% year-on-year.
Notably, the last three retail sales data points have all come in below expectations, reflecting ongoing caution among Chinese consumers.
This slower recovery can also be seen in China’s external balances.
China’s trade balance averaged CNY 254bn per month in 2019. The surplus has averaged more than CNY 400bn per month in the last three months.
This is supportive of China’s currency and financial system, but also reflects relative weakness in domestic consumption.
What we hold and why
So, with our lack of enthusiasm for the domestic consumer, what do we hold in our Chinese sub-portfolio instead?
We have substantial exposure to the real estate sector including developers and also service providers and companies with investment portfolios.
In the second quarter we added a cement company and the operator of the Hong Kong Stock Exchange.
One of our few pure consumer names is a retailer of gold and gold products, which are in effect savings vehicles.
We continue to look for opportunities in this part of the economy: construction, cement, real estate, infrastructure, and financials and asset reflation plays.
This is where we find policy support, positive macro-economic momentum, positive fundamental momentum and attractive valuations.
Although the relative country weight does not show it, this is one of our strongest conviction ideas.
James Syme and Paul Wimborne are senior fund managers and co-managers of Pendal’s Global Emerging Markets Opportunities fund.
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