Stability will be a buzzword for China in 2022, with President Xi Jinping set to win a third five-year term, Chinese-U.S. relations stuck in competition mode and Beijing easing monetary and fiscal policy to keep growth on an even keel.
One thing poised to change, however, is overseas investors’ appetite for mainland-listed A shares, after a barrage of regulatory changes under Mr. Xi’s “common prosperity” banner battered the market value of the country’s highest-profile companies last year.
Beijing’s policy revamp — which reached a crescendo in July when regulators ordered after-school tutoring companies worth tens of billions of dollars to become non-profit entities — made China a no-show this year at what proved to be a global stock market party, powered by economic recoveries from pandemic-induced shutdowns.
But Chinese stocks didn’t suffer across the board, delivering starkly different outcomes depending on where they were domiciled.
Chinese companies with U.S.-listed American depository receipts, including the country’s e-commerce giants, plunged 38% for the year, while companies with H-share listings in Hong Kong, including a number of financial conglomerates, edged down 2.7%, noted Christian McCormick, Denver-based director and product specialist for Chinese equities with Allianz Global Investors, which had €647 billion ($753.2 billion) of AUM as of Sept. 30.
By contrast, the MSCI China A Onshore index, with companies more focused on domestic demand and consumption, rose 4.03% — a “massive dispersion,” he said.
If China’s stock market has largely been viewed until now as a monolithic block, the past year’s results could prompt institutional investors to do a deeper dive on the structural differences in those respective domiciles and rethink their reliance on ADR and H share-dominated benchmarks, Mr. McCormick said.
There’s a lot of focus now on those different opportunity sets, with the exposure A shares provide to China’s fast-growing domestic consumer market garnering attention, agreed Alexander Davey, Hong Kong-based global capability head for active and quantitative equities at HSBC Asset Management. HSBC managed $619 billion in assets as of Sept. 30.
Meanwhile, there are growing expectations that the three-pronged structure of China’s listed stock universe could increasingly become two-pronged, as U.S. regulators make the price of continued Wall Street listings for Chinese companies their willingness to open their books to U.S. auditors. Beijing, in response, is putting growing pressure on Chinese companies to move their listings to Hong Kong.
The odds of Chinese companies increasingly relying on only two listing domiciles are “very high,” predicted Allianz’s Mr. McCormick, leaving investors facing a “fascinating investment experiment with a lot of variables” over the coming year or two. Ultimately, the process should be a boon for both the A-shares and H-shares markets, he said.
HSBC’s Mr. Davey said structurally, “institutional investors will be putting more money into China and I think that’s likely to be heavily focused into A (shares), and to a degree the evolving H-share market if we see some companies (trading in New York) starting to relist” there.
For now, the scars from the past year’s sell-off continue to weigh on the minds of institutional investors, in particular those in the U.S., money managers said.
The market remains gripped by uncertainty, even though the policy reset that China’s government is pursuing has been well telegraphed, with understandable goals, said Tiffany Hsiao, a managing director and portfolio manager with Milwaukee-based Artisan Partners Ltd. Artisan had $169.2 billion in AUM as of Nov. 30.
Amid all the “noise, nobody wants to do proper due diligence,” she said. Even so, continued strong earnings growth of 30% or so for A-shares companies in 2022 should pave the way for a “sentiment pivot,” Ms. Hsiao predicted.
Meanwhile, anticipated monetary and fiscal policy easing by Beijing in 2022 to steady an economy that’s slowed considerably under the weight of steps taken to rein in an overheating real estate market will provide a boost for domestic demand-focused companies in China just as other major markets, led by the U.S., are tightening policy, analysts predicted.
Cuts in commercial banks’ reserve requirement ratios in July and December show Beijing moving to cushion a slowing economy, with further fine-tuning likely in pursuit of stability, said Martin Lau, managing partner of FSSA Investment Managers, a Hong Kong-based boutique managing $38.7 billion in Asia-Pacific and emerging markets equities.
And as rates start to tighten elsewhere, China may look more attractive to global investors, he noted.
“Targeted monetary and fiscal support should boost A shares at a time when developed market policymakers are looking to tighten,” leaving the Shanghai and Shenzhen markets positioned to outperform global equities next year, wrote Celia Dallas, chief investment strategist for Boston-based global investment firm Cambridge Associates LLC, in an outlook report for 2022 released on Dec. 15.
A shares “are inexpensive relative to global equities and are relatively insulated from the regulatory stresses that have disproportionately hit the offshore market,” Ms. Dallas said.
Money managers report similar trends.
“We’re not yet seeing value emerge” among big technology companies facing continued regulatory scrutiny, said Vikas Pershad, Singapore-based Asian equities portfolio manager with London-based M&G Investments PLC. “We’re looking elsewhere,” for example to smaller and midcap companies in segments such as health care, life sciences and semiconductors.
In what could prove another potential tailwind for 2022, the succession of dramatic “common prosperity” policy changes Beijing announced over the past year to help less well-off segments of China’s population better meet their housing, education and health-care needs could be drawing to a close, analysts said.
China’s government typically takes the long view when setting policies, but the timing of some of the steps announced over the past year was likely a case of “clearing the decks” before Mr. Xi, as anticipated, officially wins an unprecedented third five-year term as China’s leader in 2022, Allianz’s Mr. McCormick said.
Once that happens, “we think that that will calm things down quite a bit” on the regulatory front, he said. And at that point, China’s A shares could well emerge as “the best game in town,” with a big, fast-growing economy and valuations that look reasonable, he added.
Some managers said they’re already moving to take advantage of more attractive A-shares valuations.
“We’ve spent the past four or five years really building out what we call a quality list of companies and ideas in China that we’d like to own, and through the course of 2020 and 2021, we’ve had the opportunity to initiate positions in a lot of those companies,” said Sujaya Desai, a Singapore-based portfolio manager and investment analyst with the sustainable funds group of Stewart Investors, an Edinburgh-based money manager with $24.7 billion in assets under management.
“We’ve added roughly five or so new Chinese companies” to the $250 million emerging markets sustainability fund Stewart Investors launched in early 2019, Ms. Desai said. They include Guangzhou Kingmed Diagnostics Group Co. Ltd., a Shanghai-based medical laboratory company offering outsourced diagnostic testing services, and Estun Automation Co. Ltd., a Nanjing-based maker of parts, such as computer numerical controls, for intelligent equipment. That represents a shift to smaller-cap companies for the 53-stock portfolio from global blue-chip names.
The sell-off, meanwhile, has made becoming conversant with “Xi Jinping thought,” as the policies and ideas of China’s supreme leader are known, a priority for portfolio managers and asset owners alike.
Understanding what the government’s long-term goals are, and how a company fits in, have become imperative, said Jack Nelson, Ms. Desai’s Sydney-based co-portfolio manager at Stewart Investors.
Just as important as alignment is figuring out what sort of profit margins the government will allow a company to make, because unlike in the U.S., in China any company making “super normal profits” will face pushback, he said.
“What we’ve been trying to do is think about which sectors not only are aligned (with the government’s policy goals) but where does your investment case rely on volume more than price,” on the premise that the government is never going to let companies make outsized profits, Mr. Nelson said.
That kind of analysis supported the sustainable fund group’s investment this year in Guangzhou Kingmed, he said. Beijing would never allow the company to charge so much for its medical tests that it could enjoy 30% margins, but the market is so fragmented and underpenetrated that even if margins halve over the coming 10 years, volume could still drive profit growth, said Mr. Nelson.
The current construction of leading benchmark indexes, however, presents challenges for asset owners that might be inclined to favor smaller-cap A-share exposure over the megacap ADRs and H shares that found themselves last year in the crosshairs of Beijing’s regulators.
A Dec. 16 report released by Boston-based quantitative equity manager Acadian Asset Management LLC, for example, cites the “active and peculiar nature of emerging markets benchmarks” — with, for example, only 20% of the Shanghai and Shenzhen stock markets included at present in the MSCI Emerging Markets index — as one factor that could prompt allocators to deviate from benchmark weightings.
The report recommends emphasizing China’s onshore market relative to its offshore market.
Whether asset owners see China’s fast-growing stock market as a historic opportunity or a house of cards, figuring out how much and how best to allocate to China “should be of first-order importance to stewards of institutional assets,” the Acadian report said.
Allianz’s Mr. McCormick said the past year has seen growing signs that asset owners, including U.S. institutional investors, are coming to appreciate the relative strengths and resilience that allocations to A shares can provide.
Data from the Hong Kong Stock Exchange’s Stock Connect program, which allows foreign investors to invest directly in mainland-listed stocks, showed record net inflows into A shares of 432.2 billion yuan ($68 billion) for 2021 — more than double 2020’s pandemic-depleted 208.9 billion yuan total while besting the previous record of 351.7 billion yuan for 2019.
More important than that number has been the consistency of net buying, with positive flows every month in 2021 despite news of various regulatory crackdowns as well as the problems of big property developers, led by China Evergrande Group, a Shenzhen-based developer with more than $300 billion in debts facing insolvency, Mr. McCormick said.
“Without question, the flows into (Allianz’s) A-shares strategies have been very strong across all regions and has started to pick up in the U.S.,” with allocations during the second half of the year from two institutional investors, he said. He declined to name them.
China’s A shares poised to star in market rebound from stagnant 2021
Policy easing and expected conclusion of regulatory reset will set the stage for domestic demand-focused A shares to shine in 2022.