Since the global sell off in February the Chinese equity sector has regained most of its losses, according to FE Analytics data.
Within the FCA Recognised universe the China equity fund sector has returned 7.13% since the beginning of the year and 4.22% within the Offshore Mutual universe.
But as the US ramps up protectionist rhetoric, investors are becoming more cautious. US President Donald Trump threatened to impose an additional $200bn in levies on Chinese goods this week days after the US announced $50bn (€43bn, £37.6bn) in tariffs over what the US deems unfair trade practices. China has said it plans to retaliate.
The Shanghai Composite index fell as much as 5% this week before a slight rebound.
China equity sector returns 31 December 2017 to 31 May 2018
Source: FE Analytics
Reduced allocations
Nordic financial services firm SEB head of asset allocation Hans Peterson said that he had reduced his allocation towards China since the trade war talks began.
Peterson said while he was generally positive on China, he was tactically cautious on Chinese equities – a position that could change depending on business cycles and the trajectory of the US dollar.
“We have decreased our holdings in Asia across the board as we had a strong overweight to the region for quite some time,” Peterson said, adding that it was a hedge against US-China trade uncertainty. “We will keep decreasing [our holdings] until the dust has settled,” he said.
Asset pricing has been affected by the trade war and needs to to be evaluated on a day-to-day basis, Peterson said. He said that if the trade dispute carries on for a long time it could create attractive pricing of some Asian assets as other investors pull out.
Caution on China
Despite the upward trajectory of Chinese equities, Financière de l’Arc fund selector Damien Armand sold his only pure Chinese fund last year, and now only holds Chinese investments indirectly through emerging market funds.
Armand said he was invested in Comgest’s Growth China fund for seven months between February 2017 and September 2017.
“We wanted to make a thematic equity bet. Usually we prefer to invest with a longer-term horizon and with fund that have a stronger conviction,” he said.
“This was a practical position. When we entered in February we knew we would cut our position just before the China election in October, so we wanted to benefit from the growth of China in the lead up to the election.”
In October 2017, the Chinese Communist Party held its congress where it shuffled its top leadership.
Armand said he was reluctant to invest in a pure Chinese equity fund or any specific emerging market as the sectors were too concentrated and due to the lack of local Chinese company knowledge.
He said that in the future he might invest back into a Chinese fund and that he was receiving more and more correspondence from asset managers about the sector since the A-shares market opened up this month.
Damien Armand top funds and Comgest China Growth fund performance three years to 31 May 2018
Source: FE Analytics
Long-term opportunities
Over the longer term, the Chinese equity sector has shown an increasing return trajectory since February 2016.
While the June 2015 share market collapse had stocks plunge more than 30%, since then even with trade war fears which started in March 2018, the sector has managed to regain losses. The sector within the FCA Recognised universe has returned 9.8% since the collapse.
While the sector within the Offshore Mutual universe has not recovered as well, the sector has made it into positive territory at 0.12%.
China equity sector returns 31 April 2015 to 31 May 2018
Source: FE Analytics
Unfair victimisation
The US characterisation of China as not playing by global free trade rules was unfair, said Ashmore head of research Jan Dehn.
“China is doing everything it possibly can to open its market on our terms and we are treating it like dirt,” Dehn said. “Donald Trump is doing everything possible to undermine the US as the current global hegemon which will help China move towards that role by 2050.”
“However, the move from Maoism to a market leader role is a large jump,” Dehn continued. “But China has moved much further towards market liberalisation and becoming integrated into global financial markets than many investors realise.”
The risk of a US-China trade war began in March this year when the Trump administration announced plans to impose hefty tariffs on Chinese goods.
“[The US actions are] the most abysmal abandonment of fiscal and economic responsibility in modern times,” Dehn said. “The fact that ratings agencies have not responded is astonishing. It tells you how rigged the financial system is.”
Fidelity International’s portfolio manager Raymond Ma believes that if China retaliates against the tariffs it could increase input prices and could prompt Chinese companies to either pass on the increased costs to consumers or allow them to eat into profits, both of which are unfavourable.
“US-China trade frictions remain broadly negative for the market and for investor sentiment, and are likely to weigh on forward earnings given the ongoing uncertainties coupled with a high base effect when compared with last year’s performance,” Ma said.
However, wealth manager GWM Investment Management’s managing director Chris Payne argues that an all-out trade war is unlikely all sides stand to lose a lot.
“It should be noted that China will soon run out of US goods on which to impose retaliatory tariffs which will move this negotiation to a more sensible and constructive forum,” he said.
Attractive sectors
Both Peterson and Armand were very positive on China’s tech sector, but Dehn is a particular fan of China’s fixed income market.
“Chinese bonds are very uncorrelated with other bond markets and offer higher yields. They tend to perform particularly well during emerging market sell offs,” Dehn said.
Bloomberg Barclays Indices announced in April that it plans to add Chinese renminbi-denominated government and policy bank bonds to its widely-tracked index. They will be phased in over a 20-month period beginning April 2019.
“Once Chinese bonds enter emerging market bond indices then we will have a safe haven bond market that we can go to whenever investors get scared. The bonds actually perform better than US government bonds in risk aversion events in dollar terms.
Dehn said that one reason why there has been a historical reluctance to include China in benchmark indices is because it will diminish the dollar’s role as the world’s preeminent safe-haven destination.
