Five myths about investing in China

Foreign investors hold surprisingly few Chinese equities given the fact that it is the second biggest stock market and third biggest bond market globally.

Some investors have been held back by views that may be either misguided or outdated.

That means it is a good time to re-examine the case for investing in China.

Here are five commonly-held myths about the investment landscape. Read on to find out why the perceived realities are often far from the truth.

5 Myths:

  • MYTH 1: Economic growth is unsustainable

    REALITY: There is sufficient growth for the market to perform

    The Chinese economy has been growing at a phenomenal rate for more than 20 years, hitting a peak of over 14% in 2007, according to data from the World Bank.

    But the rate of growth has been slowing, despite some unexpected upside over the past couple of years. This has fuelled the opinion of some analysts who say such growth cannot continue indefinitely, especially given the level of debt that many corporates and government institutions hold.

    However, even at this slower pace, China continues to grow more than twice as fast as many developed economies. The World Bank data also shows there has been growth of 6-10% over the past 7 years. This is still very strong if you put it into context, says Helen Zhu, head of China Equities for the Fundamental Equity division of BlackRock’s Active Equity Group.

    “Even just maintaining a basic, stable foundation of growth is sufficient for the market to perform,” says Zhu, adding that this level of growth will also provide a stable foundation to support the necessary structural reforms.

    Those structural reforms, in turn, will help China become not only a high-growth market, but also improve the quality of its growth relying more on domestic economic drivers.

  • MYTH 2: High debt means that China is high risk

    REALITY: China is deleveraging at a sensible pace

    Many Chinese corporates are holding a great deal of debt. And Chinese corporate debt has reached 165% of GDP, according to an IMF report, which points out that this is a high ratio by international standards.

    However, the government has indicated that it is serious about addressing the high levels of leverage that have built up and has signalled that corporate debt restructuring is now on the agenda.

    While this is a positive move for the health of the economy going forward, it also causes investors to worry about whether the Chinese authorities will be able to engineer a soft landing.

    Helen Zhu believes that corporate deleveraging will proceed at a manageable pace, and that policymakers will work hard to avoid causing a shock. And she estimates that the painful process of financial deleveraging is already well priced-in by the markets.

    Policymakers have been practical in their approach to the deleveraging agenda so far, she says, by making structural changes on one front but also ensuring that there is sufficient liquidity to avoid any stress.

    With a very high proportion of retail investors, the Chinese government is more likely than most to intervene should there be any danger of sharp falls. Economic hardship carries the danger of social unrest, and the Chinese authorities are likely to avoid that at all costs.

  • MYTH 3: Increased protectionism in the US will hit China hard

    REALITY: China is an increasingly important player in global trade

    The US-China relationship – and the potential for a trade war between the two superpowers – is undeniably influencing sentiment.

    However, despite all the tension over trade, the hugely ambitious Belt & Road initiative is still in progress. This is China’s way of boosting trade and stimulating economic growth across Asia by building a massive amount of infrastructure to connect it to other countries.

    In addition, the fact that the US has walked away from the Transatlantic Trade Partnership offers China the chance to play an even bigger role in terms of trade integration in the region.

    This means that there is also ongoing internationalisation alongside the trend of isolationism.

    BlackRock believes that trade tensions between the US and China will continue for a further period but does not think it will escalate into a full-blown trade war, although this does remain a risk.

  • MYTH 4: It is difficult to get accurate economic data about China

    REALITY: Alternative data sources provide real-time updates

    Investors worry about the accuracy of economic data that comes out of China.

    However, satellite imagery provides an alternative source of up-to-date information.

    For example, it is possible to form a picture of the ‘metalness’ on the ground as a way to measure the number of new factories being built, or existing ones expanded.

    This information helps to verify the data from the Chinese government. It is also much faster than relying on quarterly valuations.

    The information is so detailed, that the economic activity of individual companies can be compared, according to Jeff Shen, Co-CIO of Active Equity and Co-head of Systematic Active Equity at BlackRock.

  • MYTH 5: China has a liquidity problem

    REALITY: The tide may be beginning to turn here

    The inclusion of China in the MSCI Emerging Markets Index is already starting to see more funds flowing into China, albeit primarily from regional investors. Going forward, more Chinese shares are likely to be added to the index, driving even more liquidity.

    China already makes up 32.7% of the MSCI EM Index, according to its latest figures. MSCI says further inclusion of Chinese shares will be dependent on China’s moves to deregulate its capital markets and make them more accessible to foreigners. It will then launch a public consultation about whether to include more shares. But, if China does achieve that full inclusion, it could make up 50% of the index, according to Wei LI, head of EMEA investment strategy for BlackRock ETF and Index Investments. Similarly, China may eventually account for 30% of the emerging markets bond indexes, she says.

    The strength of the US dollar, together with the extended period of quantitative easing has held money in the US.

    That is now starting to change, according to Helen Zhu, with people now taking a less bullish stance on the dollar.

    “That has meant that the huge amount of assets invested in the developed market has been shifting more towards the emerging markets,” she explains. “We’ve started to see some overseas funds flow shift back, and I think that’s actually just the beginning.”

    And, as part of that trend, funds started to flow back into Asia in the second half of 2017.

    In addition, the forthcoming Stock Connect scheme, which links the Shanghai and London Stock Exchanges, will also give foreign investors greater and easier access to the shares of companies listed in mainland China.

    All these developments, together with the broader structural reforms being carried out within China, may increase liquidity.

    And as these five myths are debunked, the Chinese stock market may start to get the increased international attention it deserves.

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