The brainchild of Xi Jinping, China’s ambitious infrastructure project gives private investors an array of opportunities, argues Gregory Perdon.
China has not sought to project power beyond its immediate neighbours since the pre-colonial period, but this changed in 2013, when President Xi Jinping launched the “One Belt One Road” (BRI) initiative, intended to be the largest infrastructure project of modern times, in a bid to regain Asian hegemony.
The trade initiative aims to link more than 65 nations with more than four billion people and transform China’s standing as a political and financial force. Made up of maritime, energy, motorway and rail projects, it is expected to cost in excess of $2 trillion over the coming years.
But it is only now that we believe that private investors should pay attention, given how the BRI presents a once-in-a-generation opportunity for companies in sectors as diverse as construction, materials, education, transport, and IT services, to expand outwards.
Why are we bullish on China?
It may appear counter-intuitive as China’s economy is facing a moderation of its growth rate from 8% down to around 6%. But Economics 101 would suggest that the correlation between economic growth and stockmarket performance is not as straightforward as many may assume.
In addition, the Chinese domestic equity market suffered a significant sell-off in 2018 on the heels of the government’s desire to slow the overheating real estate market.
But after the equity sell-off, President Xi reversed course and has been administering aggressive fiscal stimulus, such as infrastructure spending, tax cuts, and the reduction of tariffs with regional partners) along with offering monetary support to the economy, such as lower interest rates, more targeted reserve ratio requirement cuts, which frees up money for new lending and growth in credit to small and mid-sized businesses.
We believe that the potential impact of these measures is underappreciated by the investment community, and this push is forging an investment environment ripe for domestic growth as China moves up the value chain and seeks to carefully manage its growth projections.
Inclusion in the MSCI Index
China’s domestic economy is no longer the closed book it was in the 20th century. In May 2018, MSCI (Morgan Stanley Capital International) confirmed that Chinese A-Shares would be added to its Emerging Markets index, paving the way for a significant increase in investor access to Chinese stocks.
The MSCI’s Emerging Markets index features 24 countries that account for 10% of global market capitalisation. In 1998, the index featured only 10 countries with under 1% of global market value. That is a significant increase and should not be underestimated.
This inclusion reflects China’s progress in liberalising and opening its markets to foreign investment, and has sparked increased flows of global capital into China, thus exposing a broader investor base to the Chinese growth story.
Looking forward, we expect the share of foreign ownership of Chinese stocks to grow. Investor appetite for a bite of China’s apple has been steadily increasing, and for the most part the inclusion of Chinese stocks in global ETFs has been met with a cautious but positive reception.
In terms of risks to the thesis, a further escalation of the trade war could dent appetite for Chinese shares. Another eventuality to consider is if we witness a significant rise in Chinese equity issuance, which would increase the supply of shares available for investment in the market.
This should be viewed against the backdrop of the trend in the US where companies purchasing their own shares - share buy-backs - has served as a key supporter of US equities.
Although the principle objectives of the Belt and Road Initiative are political and economic hegemony in the long run, in the medium term, clear investment opportunities exist that are supported by monetary support, fiscal stimulus and the MSCI inclusion. These are quantifiable catalysts that mean investors won’t need to rely on reading the tea leaves.
Gregory Perdon is co-chief investment officer at Arbuthnot Latham.