Keep Calm and Carry On

Spooked investors sent the Hong Kong Hang Seng index down 8% over two days earlier this week, amid fears of a growing regulatory crackdown. But these fears ignore the many ongoing pockets of value that active investors can tap into, argues Ronald Chan, founder and Chief Investment Officer of Hong Kong-based Chartwell Capital Limited.
Ronald Chan

Founder and CIO at Chartwell Capital Limited

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For investors not used to upside and downside risk levels in China, the past week has provided a sharp lesson.

Shares in locally listed companies providing after-school tutoring (AST) were marked down sharply on news that the Chinese government would clamp down hard on the private education sector.

In one sense, the AST crackdown should not have come as a surprise. In 2018, the government imposed new policies after a series of scandals and aggressive business tactics tarnished the education sector. 

And there is a broader context. The crackdown follows Chinese government intervention on ride-hailing platform provider Didi after it was listed in the US, suspending its ability to add new users to its app until data security concerns are investigated. This was subsequently applied to other similar apps.

Likewise, there have been previous interventions in the mobile phone and video game markets. When the government saw evidence of video game addiction levels, it suspended game approvals, and reviewed and imposed new rules. At the time the regulatory actions sent Tencent shares plunging. 

Keep Calm

The first thing investors need to do is keep the latest market swings in perspective. China remains a key investment destination for those with a forward-looking investment horizon. 

Almost 60% of the world’s population lives in Asia, with some 18% in China alone.

The World Bank pegs GDP growth in Mainland China since 1978 at almost 10% annually and says more than 800 million people have been lifted out of poverty, with significant improvements in access to health, education, and other services over the period.

By 2030, some nine years hence, 80% of the world’s middle class will reside In Asia. Domestic consumption and spending power will be huge.

China specifically also has the financial capacity, which means it can absorb large amounts of capital. This is not a region to write off because of a recent market hiccup.

Be Selective

It is at the micro-level that investors need to pick a path. Currently, the Chinese government wants to exert control and set precedents regarding limits on market forces that cause negative externalities.

Sectors that target the mass market, affect the standard of living, and ripe for consumer exploitation are the government’s focus, such as education, housing management, and healthcare.

Unfettered, winner-takes-all capitalism has consequences. The past two years have seen the CSI 300 Index gain more than 70%, so from that perspective, it is arguably a better time for the Chinese government to step in and ‘fix’ some of the industries that could be problematic going forward.

The market reaction suggests it is a tough decision. But China is a growing country and still learning. Regulation is being developed as these industries are being built. Investors could compare the recent actions to those that took place in the US around 1900 when antitrust legislation hit the likes of Carnegie Steel Company, Standard Oil, and American Tobacco.

In the context of this short-term pain and market volatility, getting back to basics and pursuing bottom-up stock-picking is the correct approach.

There will be winners in most sectors. Even if there is a regulatory crackdown in property, some companies will thrive, while in tech, there will be beneficiaries in the small- and mid-caps.

It is also a period to focus on local businesses. Many of the listed businesses in Hong Kong focus on the Greater Bay Area – encompassing nine Chinese cities, plus Hong Kong and Macau, and a population of some 70 million – are trading at levels last seen in March 2020, including restaurant chains, stores, and other businesses reliant on domestic consumption. Through these, investors can access both dividends and growth.

Significant dividend yields, over 5%, can be found among SMEs with high founding family share ownership, as they seek decent notional dividend payouts to maintain income. 

Going local also means seeking out regional trends and sectors that are favourable. Think of Europe: precision engineering across Germany is not the speciality of Portugal, which is historically a food and garment producer. Similarly, there are differences across China. 

A key upside available to investors resides in valuations. Remember, the price you pay for a company is the ultimate determinant of the return you make.

For example, given the global shortage of semi-conductors and China’s strategic focus to build its domestic industry, this sector aligns on a political and macro level. At current price levels, there are some excellent opportunities, compared to expensive Taiwanese counterparts.

The government remains positive on innovation, especially for industry and manufacturing. 

Right now I recall what Howard Marks said to me: “If you think about it, the price of an asset is a function of reality, which is the fundamentals, multiplied by the perception, which is to say emotion, psychology or popularity … And we would rather buy when the popularity or the perception is understated and we might want to avoid holding or buying when the popularity or emotion is overstated.”

Ronald Chan’s book The Value Investors – Lessons from the World’s Top Fund Managers
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