A SELL-OFF in Chinese stocks in recent weeks left some (but not all) investors wondering if the risk of further regulatory intervention outweighed the opportunities of investing in the dynamic Chinese economy.
But Pendal’s Samir Mehta, who manages Pendal’s Asian Share Fund, cautions against walking away from China, saying focusing only on managing risk means investors can miss opportunities.
Beijing’s actions have sent shudders through global investment markets, as policies aimed at improving quality of life and relieving cost of living pressures send shares reeling and leave investors wondering what else might go wrong.
“It’s easy to ask yourself what can go wrong in an investment,” says Mehta. “But equally sometimes it is just as important to ask yourself what could go right?”
Counter-intuitively, higher levels of regulation from Beijing could lift the attractiveness of the big Chinese companies as investment opportunities by raising higher barriers to entry into key industries.
Mehta draws parallels with Europe’s 2018 introduction of tight data privacy regulations — the General Data Protection Regulation (GDPR) — which triggered a sell-off in shares of affected companies like Facebook and Google.
“In reality, what has happened is incumbents have been the most benefited from this,” says Mehta.
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“Who has the money? Who has the army of lawyers? Do you think a small startup will be able to compete in an environment where the GDPR requirements are so onerous?
“The same thing is going to happen in China as this crackdown comes in.
“Who is going to be funding competitors to Tencent, Alibaba, Meituan or any of these companies?”
Mehta points out that commentators are criticising China’s intervention in the education industry in particular without considering that the kind of intervention Beijing is proposing would not be out of place in the playbook of western governments.
Beijing wants to reduce the cost of education to quell the community’s concerns about cost of living pressures by stopping companies profiting from tutoring based on the national curriculum
Similarly, there is a widespread clamour in the US to reduce the $1.5 trillion-plus in outstanding student debt, with some pushing to make America’s education system free.
“President Biden even went to the extent of saying that he was willing to write off $10,000 of debt per student,” says Mehta.
Mehta is also impressed by the high levels of competition between the big Chinese companies, which he says has the effect of creating stronger businesses.
Mehta says investors should pay attention to three key metrics to decide when the Chinese stock sell off has gone too far and if it might be time to buy.
“Equity risk premiums, liquidity and profitability — those are the three metrics that I’m looking at,” says Mehta
“Equity risk premiums reflect the negativity that starts to come in as people want a higher and higher discount rate because the risks have gone up.
“Liquidity matters because every Tom, Dick and Harry wants to sell out of China at the moment.
“On profitability, the government measures are going to impose costs on these businesses so the big question is could these be passed on to consumers because there are going to be fewer competitors that might give you a cheaper deal?
“Then finally, what will go right is that at some point in time people will realise that the incumbents are now in a significantly better position.”
Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.
Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.
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