DAVID PERRETT: Good reasons for long-term investments in China

Chinese equities were among the globe’s biggest losers in 2023 and early 2024 amid fears over weak economic growth and rising defaults in the giant property sector, among other issues.

This caused a severe loss in confidence among investors, as indicated by the equity market’s derating, rather than lower corporate earnings, as risk premia rose.

Though the market has clawed back some of those losses more recently, we have capitalised on this period of indiscriminate selling to add exposure to high-quality companies, with prospects for excellent long-term growth to our global portfolios.

By focusing on near-term uncertainties and recessionary fears of weaker profits we believe many investors have been overlooking the longer-term prospects for companies that have powerful structural tailwinds behind them and an improving approach to delivering returns to shareholders. For example, we are seeing the pace of share buybacks increase rapidly and more disciplined corporate cost-cutting.   

In addition, China is well positioned for growth against the backdrop of deflation, easing policy restrictions, a persistent current account surplus and the high levels of savings they are well-known for. At the same time, the yuan is relatively weak, so while demand from the West is low, when it does pick up China will be competitive.

Internally, support is coming from the Chinese authorities in the form of lower bank reserve requirements and fund injections into the capital market directly. Higher government spending is also expected to contribute to stronger growth.

Structural growth

There are also exciting areas of structural growth, not least industries tied to the green energy transition. China now leads the world in the installation of both wind and — especially — solar energy, as well as existing installed electric vehicle (EV) fleet and production. It is expected that renewable electricity generation will increase seven-fold in 2020-60.

However, certain parts of this sector have attracted so much capital that huge increases in capacity for commodity renewable items (such as polysilicon) have outstripped demand and led to falling prices and an incredibly competitive market, where returns on invested capital have been crushed.

Against such a backdrop investors must proceed with caution. We have adopted three broad approaches to navigate the difficult environment successfully, while still identifying stocks that should benefit structurally from the energy transition megatrend.

The first is in identifying those parts of the renewable supply chain that enjoy high barriers to entry, either through technology or regulation. We own stocks in this category that are well positioned to benefit from decent top-line growth while maintaining steady margins. A good example is Jiangsu Zhongtian, a niche cable maker listed in the Chinese A share market.

Zhongtian specialises in making the cables and providing the engineering services that connect offshore wind farms to the onshore power grid. The service it provides is both complex and critical in nature, and as a result there are only three certified players in China, of which Zhongtian is one.

The scale of the offshore buildout in Chinese wind farms means these three cable and engineering companies are the largest in the world, which is allowing them to win lucrative export orders in an industry that is facing ever tougher capacity constraints on a global basis.

The second approach focuses on those commodity-based producers that either have scale, vertical integration (supply their own key components at a low cost) or both, and thus have a structurally competitive cost advantage, which will allow them to remain profitable through this period of intense competition. Importantly, with general negative sentiment towards all things China at present, both groups of stocks can be bought at undemanding valuation levels.

The final approach is to identify sectors or industries that will benefit tangentially from the energy transition. Shipping and shipbuilding are two such sectors. Shipping is a cyclical sector that experienced 10 lean years from 2010, during which boom turned to bust so that ships ordered in peak demand years arrived in a depressed market sometime later.

Looking forward, shipping (especially bulk shipping) now has a healthier demand/supply balance. Importantly, due to uncertainty about the new climate-friendly fuel standard — methanol, ammonia or hydrogen — ship owners have been reluctant to order new ships, fearing any deliveries may become obsolete before their 20 year useful life has expired. This is instilling an enforced supply discipline in bulk shipping that we have not seen in the past.

Similarly, shipyards are benefiting from the energy transition. During the past decade many yards were forced to close due to a lack of orders. This reduced both physical and human capacity for building ships. As a result, remaining yards are in a strong position to cherry-pick the most lucrative of orders, given full order books out to late 2026 or even 2027.

With thousands of ships that need to transition in the next 20 years it is plausible that an historically cyclical industry such as shipbuilding will resemble, for a prolonged period, a structural growth story. In the shipping and shipbuilding stocks that we own such a positive, structural outcome is by no means discounted by current valuations. 

As a last consideration, active investors who engage respectfully with companies — through what we call “value-added shareholdership” — can add greater value to the companies they invest in, whether it be through better corporate governance, shareholder returns or improved sustainability actions. 

Amid all the present uncertainty current valuations in China offer a wide spectrum of exciting, long-term opportunities for active, bottom-up stock-pickers such as M&G. Reflecting this view, our global multi-asset funds are overweight Chinese equities to take advantage of this for our clients.   

• Perrett is co-head of Asia Pacific Equities at M&G Investments (UK).