JACOBUS BRINK: Get boots on the ground to invest in China with confidence
Local fund managers know the landscape, culture, companies and when potential changes are afoot
Despite its numerous challenges, China provides many compelling investment opportunities. But you’re not going to find these by studying spreadsheets in Cape Town or relying on a fund manager flying between London and Beijing every few months.
It helps to have someone on the ground, local fund managers who know the domestic landscape, the culture, the companies, the competitors, the regulations, the risks, and a reading of when potential changes are afoot.
Investing in China is no longer the one-way bet it used to be when GDP growth was galloping ahead at an average of 10% a year. Its accession to the World Trade Organization in 2001, and the opening of parts of its economy, resulted in a flood of foreign investment into the country, rounding off reforms that had started in 1978.
According to investment banks such as Nomura the Chinese economy has cooled considerably; it might not even expand 3% in 2022. In July the IMF estimated that the US economy would expand 2.3% in 2022 and the eurozone 2.6%. It pegs China’s growth at 3.3% this year (from an April estimate of 4.4%).
The main Shanghai index has declined 9% over the past five years, while the benchmark Shenzhen index is lingering near 2020 levels. Strict Covid-19 lockdowns have stalled output, caused fresh supply chain snags, and cut consumption. A meltdown in China’s property market has dragged consumer confidence to record lows and weighed on business sentiment. At the same time, the manufacturing sector contracted for the first time in three months in August as demand weakened.
One analyst at an international investment bank called Chinese technology stocks “uninvestable” in March — costing the bank a role in an initial public offering and causing tech stocks to plummet. The analyst and his team upgraded their assessment two months later.
The analyst’s initial negative outlook was due to the uncertainty created by a crackdown by Chinese regulators on tech companies, the nation’s souring relationship with the US, Europe and other Western countries, and its deteriorating macroeconomic outlook. He revisited the valuations amid signs that an auditing dispute between US regulators and Chinese firms had eased, while also citing an improving geopolitical environment and other regulatory improvements, spurring a jump in Chinese tech stocks.
It shows just how complicated China is — even for global banks and economists with decades of experience in the country of more than 1.4-billion people.
It shows just how complicated China is — even for global banks and economists with decades of experience in the country of more than 1.4-billion people. It is a different game for fund managers and their clients who are not encumbered by having to make public stock recommendations, chase corporate deals, work with or advise governments and companies, or seek wholesale or retail banking clients.
An investor’s primary goal is to make returns in ways that are not detrimental to the planet or its people — not investment banking fees or commissions. Multimanagers, for instance, can research money managers, find the best performers, match them to their strategy and culture, and then invest a portion of their clients’ funds with them.
A relationship between a multimanager and an underlying fund manager with an on-the-ground presence in another country is not established overnight. It is built over time following much due diligence work. Besides, fund managers have access to the analysis compiled by investment banks and other research houses. They assess these against each other, within their teams and with their in-country money managers.
Over the past 10 years several investors, even sophisticated ones, were chasing performance during the bull market in consumer and internet companies. Over this time, even subpar fund managers produced exceptional performance.
The market situation changed in 2021 due to a mix of changing legislation and sluggish economic growth. Few of the successful managers over the prior five years had the agility to switch their positioning. Sadly, many who were expecting a turnaround this year have not improved their performance. With huge drawdowns, lost revenue and staff flight, we have reached a point where even the viability of some fund managers could be in question.
Therefore, given the market- and macro-environment’s quick shift of late the case for being nimble and taking a multistyled investment approach is especially applicable to the Chinese markets. Moments like these serve as a crucial reminder of the importance of selecting managers on core principles such as manager skill, diversity and risk management. We have long observed that choosing a manager in China requires specialised knowledge.
Multimanagers can build overarching, well-diversified portfolios that account for risk. Some allocate funds to managers that use hedge fund strategies, derivatives or other nonconventional means to insulate investments from market volatility or to make money in a downturn. After the opening of the derivatives market in China in 2015, managers can actively hedge any downside risk they might be concerned about and in general manage their portfolios more efficiently.
If you pick the right stocks there is plenty of upside. Value as a style has been a case in point. Value managers have been fairly out of favour in a growth-driven market over the past number of years, but these managers have now started to outperform as the market environment shifted.
The country’s growth potential — which even this year is poised to outpace the US and Europe — and its population, mean China cannot be ignored. It will overtake the US at some point as the world’s biggest economy. The Chinese central bank cut key lending rates twice within a week in August, signalling that authorities are willing to stoke the economy back to life, even though the national government has thus far been slow to react to the woes in the real estate market.
As with all things there are many risks; you never know what will change or be implemented next, but this is nothing new when it comes to China. The country is not “uninvestable”. It is a buy — just use discretion and don’t fly in blindly or alone.
• Brink is head of investments at Novare Holdings, a multimanager with R10bn in assets that uses hedge funds as part of its investment strategies.
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