China has been flexing its regulatory muscles of late. It started with a clamp down on the tech titans last year, when the likes of Tencent and Alibaba were seemingly getting too big for their boots. A focus on anti-competitive practices and protecting customers’ personal information quickly brought them back in check and reminded them who’s boss.
Since then, things have ramped up and, according to James Thomson, manager of Rathbone Global Opportunities fund, there were no fewer than 30 regulatory interventions in August and 24 in the first two weeks of September alone.
The most newsworthy events this year started with a sudden and sweeping overhaul of the afterschool tutoring industry, which basically banned companies in this sector from making profits, raising capital overseas or going public.
There has been a slower burn on the real estate sector, which has come to a head in recent days. For some years, the Chinese government has been trying to wean property developers away from excessive borrowing, but debt and land-buying curbs – along with a myriad of new rules – has hit companies harder than expected.
As if that wasn’t enough for investors to digest, the regulators then intensified their crackdown on cryptocurrencies, with a blanket ban on all crypto transactions and mining. When it comes to risk, the real estate sector is probably the greatest because no one really knows the extent of the problem.
Chinese developers borrowed heavily from investors all around the world, using the cheap debt to finance apartment blocks and houses all over China. However, many companies overstretched themselves, repaying maturing debt with ever more debt as they chased sales growth. This finally come to a head last week, when Evergrande, China’s largest real estate developer, missed a payment to foreign investors after new government rules stipulated those over-leveraged developers must repay old debt before issuing any more.
Will there be a bailout from the Chinese government?
Market opinion is divided on whether the government will rescue Evergrande or let it fail as a warning to the rest. But there is agreement that Chinese government is unlikely to let the situation escalate too far.
Rob Brewis, co-manager of Aubrey Global Emerging Market Opportunities, said: “The last thing the new “Common Prosperity” initiative needs is the distraction of large numbers of people who have put down deposits on unfinished projects or have invested in some bank wealth management products with exposure to the group being left penniless. Much of the debt will be with government banks who will, no doubt, manage the bad debts down over many years. It will be a massive headache, but not in any way a systemic risk.”
Martin Lau, manager of FSSA Greater China Growth fund, added: “China is a closed system, so the contagion risk is limited to an extent. Everything is ultimately owned by the government so they can step in and stop the rot if they need to. The economy will probably grow at a slower rate as a result of the troubles, but even that is not such a worry for the government as it is now more focused on quality of growth rather than the quantity.”
So, what is the outlook for Chinese equities?
China was the place to be for investors last year, when the stock market returned 25.5 per cent*. To put this into context, the S&P 500 driven in no small part by its own big internet companies, returned 14.1 per cent*.
This year, however, while the US index has continued to make gains, the uncertainty in China has led to falls of 17 per cent year to date**. James Thomson says that while he doesn’t think China is now univestable, it does require a certain skillset and specialist expertise to invest in the country today.
So investors shouldn’t necessarily be put off, just cognisant of the risks. Paras Anand, Asia Pacific chief investment officer at Fidelity, said: “For long-term investors, the indiscriminate sell-off has created good opportunities to look for bargains, especially among companies whose growth trajectories remain intact. We believe the overarching aim of recent regulation is to foster sustainable growth and boost social equality. Despite policy headwinds in some sectors, China is still on track for decent GDP growth over the next decade, while its middle class should continue to grow and see its purchasing power increase as income gaps are narrowed.”
Martin Lau also highlighted particular areas of interest: “China has a very aggressive target for carbon neutrality and strong social programmes,” he said. “There is a real focus on developing renewables now and the environment is top of the agenda for government officials – even ahead of GDP growth.”
Andy Rothman, investment strategist at Matthew Asia, concluded: “People in China are having the same debates and discussions as we are. They have concerns over competition, consumer rights, protecting small businesses, data protection, security and inequality of opportunity. But one of the big differences in China is that, as a one-party ruler, it can act more quickly. One of the reasons the Chinese communist party has ruled China for as long as it has is that it has been pragmatic and increasingly market orientated. And there are no signs it wants to wind this back.”
*Source: FE fundinfo, total returns in sterling, calendar year 2020
**Source: FE fundinfo, total returns in sterling, 1 January 2021 to 28 September 2021
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and commentators and do not constitute financial advice.