Today is Chinese Lunar New Year falls (16 February) and in accordance with the Chinese zodiac it will mark the start of the Year of the Dog. As with so many things to do with China, the numbers linked to the Chinese Lunar New Year holiday season are simply staggering. The holiday period sees the largest mass migration on the planet, known as Chunyun, when over 2.5 billion trips are expected to be made as people travel between cities and villages over the coming weeks to be with their relatives.
From a long-term investment perspective, it is difficult to resist getting excited about China, a vast nation which has industrialised at a truly astounding pace. In 1980 the Chinese economy was less than half the size of the Italy’s in GDP terms. Today it is the second largest economy after the United States. While China accounts for around 15 per cent of global GDP – and almost one in five of the world’s population – the representation of Chinese equities in the MSCI All Country World Index is less than 4 per cent, so there is clearly capacity to significantly grow its share of the capital markets.
Yet in recent years many market watchers have taken a more sceptical view of China, concerned about the rapid growth of the debt in the country – with total debt to GDP estimated to stand at 317 per cent. Chinese GDP growth, while outpacing the developed world, has also decelerated significantly from 10.2 per cent in 2010 to 6.9 per cent last year. A third factor that casts some doubt over the long-term outlook for China is that its demographic profile is set to deteriorate with echoes of the trends seen in Japan. Birth rates have continued to fall in China despite the scrapping of its disastrous and controversial ‘one child’ policy in 2016 and the percentage of the population aged over 60 increased from 16.7 per cent in 2016 to 17.3 per cent last year. As the Chinese population ages and the workforce declines, this is leading to a shortfall in its pension system.
China’s authorities have acknowledged these challenges and the 19th Congress of the Communist Party in October last year marked a shift in policy towards a greater balance between social and environmental improvement versus headline economic growth. Chinese authorities are reigning in the expansion of credit to address the risks in the Chinese financial system and aim to achieve a more sustainable rate of economic growth.
These big picture themes and challenges are debated by economists and investment strategists at great length. Unsurprisingly it is easy for investors to get tied up in knots when considering whether or not to have any investments in China. However the simple fact is that there is no relationship between Chinese GDP growth and returns from Chinese equities.
What can easily be seen as ominous challenges today may turn out to be investment opportunities as technology is used to improve productivity and address labour market shortfalls and private savings are encouraged to address the financing of retirement.
What really matters over and above the GDP outlook is whether there are promising private sector Chinese companies to invest in that can deliver a good return on equity. In this respect it is important to tread carefully as the Chinese markets include many listed companies that are nevertheless controlled by the State and where commercial priorities can be eclipsed by political considerations. China is a market where we think it is important take a selective approach, but which investors should not ignore either.
For most investors, the most appropriate way to access China will be through a broader Global Emerging Market fund or Asia ex Japan fund rather than a single country China fund. High quality funds to consider include Schroder Asian Alpha Plus, which has 30.3 per cent in Chinese companies and 20.3 per cent in Hong Kong, and Fidelity Emerging Markets which is 22.7 per cent invested in China and 8.8 per cent in Hong Kong shares.
Jason Hollands is managing director of Bestinvest.
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