China is a top destination for investors, but investing in the world’s second-largest economy requires a tour guide. As U.S.-China tensions escalate, investors need more than a cursory understanding of the political and economic challenges. Especially since, as any intrepid tourist knows, it’s better to buy local—in this case, companies on Chinese exchanges—rather than limiting yourself to U.S.-listed Chinese companies or multinationals.
Investors moved swiftly into Chinese stocks toward the end of last year, making short-term gains less likely. But the longer-term prospects are still very appealing. As other countries were still grappling with the Covid-19 pandemic, China began to recover, becoming the only major economy to grow in 2020. Stocks climbed; the
iShares MSCI China
exchange-traded fund (ticker: MCHI) rose 28%. In the near term, other emerging markets hold more potential as they rebound, vaccinations increase, and an economic recovery takes hold. Indeed, Chinese stocks have lagged this year, hurt especially by increased regulatory scrutiny and antimonopoly measures targeting the country’s internet giants, which have dominated the market. The iShares MSCI China ETF this year is up just 2.5%, trailing most other global markets.
That could present an opportunity, especially given how enthusiastic many managers are about the long-term opportunities in China. Unlike much of the rest of the world, China didn’t flood its economy with as much stimulus, putting it in a better fiscal position. Officials are also investing aggressively to bolster the country’s competitiveness in technology and hit its carbon-neutrality goals, and Chinese consumers are spending more on services like education and healthcare.
Note: Five-year returns are annualized.
Source: Morningstar Direct
As China celebrates the 100th anniversary of the Chinese Communist Party this month, Beijing is thinking carefully about its future. Global policy makers, meanwhile, are reassessing their approach to China, which could make investing there more complicated. Investors eyeing the selloff in China for opportunities should seek out a mutual fund or exchange-traded fund to access the long-term opportunity and get some help navigating the many risks—including the blacklisting of 59 Chinese companies and plans to delist Chinese companies on U.S. exchanges that aren’t in compliance with U.S. auditing standards.
“The question is not whether to stay in China, but how to do so and how to manage the risk of additional sanctions,” says Arthur Kroeber, head of research at Gavekal Research. He says that most of the firm’s clients see an allocation to China as a must because of the growth prospects and returns.
The risks of investing in China were on full display early this year when
China Mobile
(941.Hong Kong), a widely held telecom company, was delisted, following an executive order from President Donald Trump that banned U.S. investment in companies that the government said were tied to China’s military complex. The order, which required U.S. investors to divest by this fall, sent investors scrambling as the New York Stock Exchange delisted the company. While most institutional investors were able to sell or swap to the Hong Kong–listed version of the shares, retail investors have had a harder time. Many are still stuck in limbo, unable to sell shares through most brokerages and without much guidance on what to do.
Measures aimed at boosting U.S. competitiveness against China and addressing longstanding issues with China around accountability and transparency, not to mention human rights, are expected to continue—and even intensify. The Senate passed a sweeping China bill that is now working its way through the House, which has its own version, but taking actions against China has strong bipartisan support.
The Securities and Exchange Commission and the Public Company Accounting Oversight Board are still sorting through how they might implement recent legislation that would delist Chinese companies not in accordance with U.S. accounting practices. While Chinese companies are still listing in the U.S.—ride-hailing company
DiDi Global
(DIDI), for example, just went public—they are also increasingly seeking secondary listings closer to home to minimize the risk of a delisting and tap investors who are more familiar with their businesses.
Money managers are also allocating more to domestically oriented companies, often listed in the onshore A-shares market. They’re focusing on companies that can benefit from China’s increasing investment in technology to bolster its competitiveness, and as Chinese companies look to local suppliers amid worries that more U.S. restrictions on sales to China could make U.S. suppliers less reliable.
While some brokerages, like Interactive Brokers, allow clients to invest in foreign markets, others don’t—making it harder for retail investors to tap the parts of China that professionals say are most attractive. These three active funds and one passive option are good options for investors looking for a way to invest in China.
One of the biggest and cheapest active China-oriented funds is the $2.4 billion
Fidelity Advisor China Region
(FHKAX) fund, which ranks in the top decile of its category over the past five- and 10-year periods, averaging an annual return of 22% and 11.3%, respectively. It charges an expense ratio of 1.24%.
Half of the fund’s top 10 holdings are in the nation’s biggest internet companies, including
Alibaba Group Holding
(BABA) and online food-delivery firm
Meituan
(3690.Hong Kong). Roughly a third of total assets are invested in businesses related to the internet, contributing to the fund’s more middle-of-the road performance this year, with a return of 5%.
Co-managers Stephen Lieu and Ivan Xie take a “growth at a reasonable price” approach as they look for higher-quality stocks domestically. That includes searching for companies that can benefit from younger Chinese consumers becoming more confident in domestic brands—which are gaining market share from international competitors—and from China’s efforts to build up its semiconductor and software ecosystems, both of which are critical for Chinese technology. “We also see a lot of opportunities in areas where China could potentially take global leadership during the ongoing technological evolution, such as electric vehicles, autonomous driving, and renewable energy,” the managers said via email.
Another stalwart, the $1.8 billion
Matthews China
(MCHFX) fund, has a long track record and is even cheaper, with an expense ratio of 1.09%. The fund beat 99% of its peers over the past 15 years, with an average annual return of 12.4%. Its 7.4% return this year puts it in the upper third of its Morningstar category. Top holdings include Chinese standbys such as
Tencent Holdings
(700.Hong Kong) and local shares of Alibaba Group, as well as financials like
China Construction Bank
(939.Hong Kong) and
China Merchants Bank
(3968.Hong Kong).
Chinese stocks have been roiled by recent regulation, but Matthews China co-manager Andrew Mattock sees these types of reforms as probably continuing in other parts of the market, noting that they are part of the structural micro-reforms that President Xi Jinping has pursued through his tenure. Xi’s initiatives included an early anticorruption drive, crackdowns on peer-to-peer lending and wealth management, and drug-price regulation.
But Mattock also is finding a wider array of Chinese companies that benefit indirectly from the changes created by escalating U.S.-China tensions and the heightened strategic competition with the U.S. The Senate recently passed sweeping legislation aimed at reducing U.S. dependence on China for critical supply-chain products, like semiconductors. As a result, demand is booming at local Chinese companies, which are getting orders that used to go to Western rivals.
“The biggest thing that has changed is the [now] across-the-board preferential treatment for [Chinese] IT companies that have a Chinese supply chain,” Mattock says. “If there’s a foreign automation company versus a local one, they are giving their orders to the Chinese guy, even if they’re not as good.” Demand is also booming at local Chinese chemical companies or anything battery-related, Mattock says.
Funds like the $109 million
Aberdeen China A Share Equity
(GOPAX) focus on China’s domestic A-shares onshore market. Nicholas Yeo, the fund’s co-manager and Aberdeen’s head of equities for China, likes companies with consistent and profitable growth and solid balance sheets. Over the past three years, its average annual return of 21.7% beat 88% of its peers in the China region, while offering investors a smoother ride with strong risk-adjusted performance, according to Morningstar’s analysis.
One area of focus is the Chinese consumer, especially aspirational millennials. “We’re confident that rising disposable incomes and increasingly health-conscious citizens will spur demand for healthcare products and services,” Yeo says.
Fund managers are also finding opportunities in parts of the market where U.S.-China relations are friendlier, such as financial services. China has been opening up its capital markets to foreign investors and has eased restrictions to allow financial firms greater access to China’s markets. Yeo, for example, recently bought shares in a technology company that helps financial firms with portfolio management and trading platforms.
Similarly, China’s commitment to hitting carbon neutrality by 2060 makes companies tied to renewables, batteries, electric vehicles, and related infrastructure attractive. The nation has significant dominance in global renewable-energy and battery supply chains, Yeo says. Beijing is also increasing tax breaks for research and development to spur innovation and reduce dependence on Western technology. Clinical-research organizations that service drugmakers stand to benefit, as well, Yeo adds.
Regulation is still a concern, though, especially for industries that have grown rapidly. Internet giants like Alibaba, for example, have fallen 28% since last fall, when Beijing regulators scuttled the highly anticipated public offering of Ant Group, controlled by Alibaba co-founder Jack Ma, and increased scrutiny of internet behemoths. That has led companies like Ant to overhaul their business models and forced investors to reassess growth prospects more broadly. The volatility created by regulatory clampdowns, however, could create buying opportunities. Chinese tech companies are increasingly attractive for long-term investors, says Yeo.
Indeed, investors are beginning to bargain hunt, drawn by cheaper valuations, says Brendan Ahern, chief investment officer of KraneShares. The
KraneShares CSI China Internet
ETF (KWEB) is down almost 8% this year, putting it at the bottom of the category of China funds, but its price/earnings ratio is below its five-year average. Chinese internet stocks also look attractive versus their peers, with a P/E-to-growth, or PEG, ratio of one, half that of their U.S. counterparts, according to Ahern.
The fund is a concentrated bet on the internet, but allows investors to tap into an array of internet businesses that have been supercharged during the pandemic. It gives retail investors a way to own newly public internet offerings like ride-hailing company
DiDi Global
(DIDI), which priced at the high end of its expected range at $14 and raised $4 billion in the offering.
Write to Reshma Kapadia at [email protected]