Chinese equity markets have changed dramatically as the local economy has shifted from being primarily export-oriented to focusing on innovation. As a result, China, which had a 0% weighting in global indices just over 25 years ago, has become the most heavily weighted country in emerging market equity indices, accounting for 43% of the MSCI Emerging Markets Index and rapidly gaining share in fixed income indices.
With a market capitalization of $19 trillion, second only to the US, and more than 6,000 listed companies, the Chinese markets as a whole (A-shares, H-shares, ADRs and S-shares) cannot be ignored by investors today. This is why we interviewed Haiyan Li-Labbé, an expert on China’s equity markets and manager of the Carmignac Portfolio China New Economy fund at Carmignac, to show us what the attractiveness of Chinese equities is in a post-pandemic context.
1. What does leveraging the growth potential of China’s new economy mean?
Carmignac has developed a strong expertise on emerging markets and Chinese markets since its inception in 1989. The focus on actively selected Chinese equities have been present in our global portfolios since then. The Chinese equity market has changed dramatically as the local economic base has moved from being mainly export-industry-led to focusing on innovation. Within Carmignac’s EM strategies we are investing in sustainable growth themes arising from China’s new economy with a high level of selectivity to identify the highest potential companies with a particular focus on sustainability. China’s new economy (spanning digitisation, healthcare, new consumer lifestyles and cutting-edge technology) offers major opportunities for generating alpha because it will remain the primary growth driver in the coming decades.
Our approach focusing on the Chinese New Economy, the most attractive segment of the Chinese market in our view, to take advantage of structural reforms and four key long-term trends: digitalisation, technological innovation, healthcare, new consumption patterns and clean energy.
The reference to the “New Economy” reflects our focus to invest in sectors not explicitly linked to the purely exporting component of the economy or to traditional commodities. This involves being present mainly, but not solely, in sectors linked to consumption, low-carbon energy, technological innovation and the phenomena of urban migration and rising living standards.
We have a differentiated, selective and active approach focusing on sector leaders within New Economy sectors, and not replicating our reference indicator by investing in the biggest components of MSCI China Index.
2. What is compelling about China’s equities, post-pandemic?
After effectively managing the pandemic and monetary and fiscal policy, China looks set to record GDP growth of over 8.5% in 2021.
At Carmignac, we focus our investments on consumer companies that are mainly addressing the needs of the growing domestic demand mainly in Consumption related sectors (such as hotel, travel and retail, eCommerce, online social media platforms &, smart household equipment) and capitalize on long term demographic / consumption upgrade trends (education).
Looking forward, to the post pandemic trends, we still like new economy sectors which should continue to benefit from China’s long-term reforms. In China’s 2021-2035 plan, the main focus areas are digitalisation, renewable energy, tech innovation, consumption and healthcare. The government roadmap provides clear investment guidance to investors for the long run. Hence, we continue to like our long-term positions in healthcare, education and eCommerce (beneficiary amid consumption), electric car, could and data centres. However, as these sectors have had phenomenal performance this year, they might not perform as strongly as last year. Huge liquidity injection from all the major central banks also contributed to re-rating of these sectors. As economy rebounds, we expect moderate tightening in second half of 2021. Consumption should catch up industrial production and infrastructure spending. With vaccination pace picking up and gradual economy reopening, we believe that there are good investment opportunities within quality cyclical sectors such as home appliances, auto (especially legacy auto makers which are entering EV area), travel and logistics (which should benefit from better infrastructure).
3. What are the primary risks that all investors should bear in mind when it comes to investing in China?
The potential risks to monitor are: Geopolitical risk and mainly US China relations, the monetary and fiscal policy (tightening in the second half of the year), direction of US interest rates, market flows, sectoral rotation, vaccine deployment
- Geopolitical risks, primarily US-China tensions which could impact some tech stocks and Chinese companies listed in the USA. Even though Joe Biden doesn’t appear to be contemplating a more aggressive approach to Beijing than his predecessor, US-China relations are still fraught with tension, as illustrated by the somewhat adversarial tone adopted by both sides at the recent Alaska talks. Worth noting that we do not invest in stocks which are on US entity list or stocks which could be added onto US entity list.
- Monetary and fiscal policy (possible moderate tightening in the second half of the year): We are not too concerned by this as PBOC governor Yi reiterated that monetary policy will maintain stability and continuity, and a policy cliff should be avoided.
- US Rates: Although higher US interest rates could hurt the Chinese equity market, we are maintaining our constructive outlook for the country’s new economy. As its growth is based on sounder fundamentals, we feel it can handle any adverse impact from rising interest rates.
- Vaccine deployment: already 880 million doses administered so far, official data provided by Chinese Government.
4. What are Carmignac Portfolio China New Economy’s three main positions?
- Chongqing Zhifei (vaccine distributor & maker)
Leading private-sector vaccine producer and distributor with an extensive distribution network and cold-chain logistics system. Zhifei has a strong own vaccine pipeline (and managed to develop a COVID 19 vaccine) and has an is exclusive distribution contract with Merck.
- Miniso (lifestyle retail, global player)
Miniso is a Chinese company operating offline stores that specialise in household and consumer goods including cosmetics, stationary, toys and kitchenware.
China has one of the world’s biggest branded variety retail market with fast growth. Miniso is a leading company in both Chinese domestic and global branded variety retail market with decent market share and strong presence with 4300 stores in more than 80 countries (60% in China and 40% overseas) Source: Company data, Bloomberg, 30/04/2021
- Ehang (eVTOL electric vertical takeoff and landing aircraft, leader)
China’s top electric-drone manufacturer. The company’s drones are already in use in China for topographic mapping, aerial photography and fire-fighting. But the market has yet to price in the potential of air taxis – and Ehang has already signed several contracts for such taxis with a number of tourist sites in various Chinese cities. (Sources: Company data, Roland Berger Research, Based on 31/03/2021 company disclosure & report)
5. Do you factor in ESG criteria when evaluating companies?
Carmignac Portfolio China New Economy has a sustainable and responsible approach. Indeed, as an Article 8 Fund under EU SFDR classification, we favour companies that deliver solutions to environmental and social challenges of the Chinese economy and society. The Strategy
- Consistently takes into account ESG criteria (Environmental, Social and Governance). We rank detailed ESG rating to each of our stocks.
- Aims to minimize its environmental impact by reducing its carbon footprint by 5% per year.
Regarding ESG investing in China
Green energy and environment are key long-term development areas in China’s 2021-2035 plan. We are seeing significant efforts of better ESG reporting & disclosure from Chinese corporates. China has set up Carbon Neutrality goal for 2060, very concrete actions are being taken. China is not late in this area, and even in advance compared to many countries. At Carmignac, we interact actively with our investee companies and try to engage with them based on our SRI investment framework and our ESG criteria.
6. What is the average number of companies that you meet each year?
On average, on a normal year, we meet 20-30 companies each year. However this number has been slightly different in 2020 due to Covid travel restrictions and we had to replace some of the on site visits by conf call with management of companies.
7. What kind of companies would you never invest in?
• Inefficient State-Owned Enterprises (SOE) that have spent the years misallocating capital, which don’t comply with market rules, bad ESG rating companies.
• Overleveraged companies, with a high net debt-to-market capitalisation ratio, bearing significant credit risk;
• Companies in saturated sectors – such as construction – that are adding to overcapacity issues (for example the steel industry in China) without the necessary growth drivers;
At Carmignac, we try to pick out the “attractive” part of our Chinese investment universe by focusing on capital-light companies. We look for businesses offering attractive and sustainable cash generation that are capable of self-financing their growth in New Economy sectors. We would focus on stocks having low gearing ratio, solid FCF, friendly to minority shareholders and good corporate governance companies.