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Quilter Cheviot: The opportunity in China

22 September 2020

Quilter Cheviot's Nick Wood explains why investors should consider an allocation to China and which funds he likes for exposure to the world's second-largest economy.

By Nick Wood,

Quilter Cheviot Investment Management

In the next 10-20 years, every investor is going to turning their attention to China. Away from the more dramatic political machinations, we are all getting very used to companies such as TikTok, Alibaba and Tencent, and it is fairly likely that in a diversified portfolio you might well have exposure to any one of these names. It also won’t have escaped the attention of most of you that the Chinese stock market has been on something of a tear recently. But what about the longer-term future of the Chinese stock market and its place within a diversified portfolio?

The Chinese A-share market, or the onshore market, is something that that has fascinated me for a while, particularly some of the nuances of the market versus other parts of the world. On the one hand it has characteristics of the major developed markets – it is very large and liquid – but it also lacks some basic instruments, such as a futures market. The A-share market is heavily dominated by retail investors, who are estimated to make up around 80 per cent of daily trading. The time horizon for the average Chinese retail investor is noticeably short; more akin to a lottery ticket than what we might consider as a long-term investor, with holding periods measured in days and weeks in most cases.

Locally based domestic fund managers are not so dissimilar. Turnover in portfolios managed by local Chinese asset managers is often in the 300-400 per cent range and can be higher. In the UK or US, that number would typically be up to 100 per cent, but some are as low as 20 per cent. Anyone with a willingness to invest for the long term, there are likely to be regular buying opportunities given the market dynamics. This is backed up by the performance of active managers – it has been a pretty fruitful place to invest with 94 of the 103 managers with a five-year track record within the IA China universe ahead of the MSCI China index.

When thinking about China from a fund research perspective, investors do have to think about whether they should buy an emerging market or an Asian manager, or a fund solely invested in China. There are pros and cons to both approaches. A specialist might be expected to have greater knowledge of the specifics of China, although plenty of generalist funds with large teams might claim equal knowledge. Many generalist funds will have analysts focused specifically on China, which will account for a decent proportion of holdings. Emerging market and Asian funds do have the ability to compare the opportunities in China versus other equally interesting economies, such as India or Vietnam, however. That would seem to give the edge to the generalist, but I think it ultimately comes down to finding the most skilled managers across both the regional and China-focused universe, of which we have come across a few.

Our preference is Fidelity China Consumer, managed by Hyomi Jie. As the name suggests, it focuses on the growing middle-class consumer in China and offers exposure to the more exciting, new economy areas that you would expect such as consumer staples, discretionary and communication services. However, given the trend of increased wealth and a focus on wellbeing, financials and healthcare are also key emphases for the fund manager, providing a well-diversified portfolio.

There are longer-term considerations behind treating Chinese exposure as a separate entity in a portfolio, in the way we consider Japan for example. The argument in favour is that the progression of China within global indices, with an ever-increasing weight, along with the natural growth rate of the economy, should mark it out for individual attention. Let us not also forget that China is already the world’s most populous country and second-largest economy. That is a fairly compelling long-term argument in my view.

Interestingly, despite quite a spate of China fund launches in the last three years, flows haven’t been that great. Taking the onshore IA China/Greater China sector, the 37 China specialist funds manage £14bn in total – a reasonable number, but there is around 10 times that invested in emerging market and Asia funds. Looking across at the investment trust space, there are actually only three China-specific trusts, with the most recent one being last week’s announcement that Witan Pacific is being passed to Baillie Gifford to be run as a China mandate (and now known as Baillie Gifford China Growth Trust). As it happens, we have just passed the 10-year anniversary of the largest China trust, Fidelity China Special Situations. I’m not sure local managers with extreme turnover are quite for me, but some more familiar names have done well so far. We may not have seen a lot of flow into funds, but I think this will change over time.

So, what does the future look like for the region? Well, one clear trend is that larger asset managers are beginning to open offices in China in order to have a presence and increase local knowledge, and the market seems ripe for active management to shine. It might still be some time before we see China as a separate entity within portfolios, but if you are investing, it seems an incredibly compelling opportunity – a market value rapidly growing within global indices, and an environment that is incredibly inefficient in many ways. As for recent performance, well buyer beware in terms of the volatility, but so long as you are thinking longer term, it is hard to ignore this market.

Nick Wood is head of investment fund research at Quilter Cheviot. The views expressed above are his own and should not be taken as investment advice.

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