David Choa, head of Greater China Equities, talks about investment opportunities and the application of environmental, social and governmental (ESG) criteria to investing in Chinese equities.
China is an interesting case. While it presents downsides and risks, there are several positives on the horizon.
We have already seen three consecutive quarters of earnings downgrades and, after August, there will likely have been four, so market expectations are much lower now.
China faces two major hurdles. One is the property market, where there is still a big overhang. While the government is now more reactive, we think it’s not doing enough. The second is China’s zero-Covid policy, but I think there’s scope for the government to ease back on this after the Party congress in mid-October.
Technology innovation is a positive area that now embraces companies beyond the online firms that people are familiar with. Many of these used to be at the lower end of the value chain, but they’re slowly catching up with Western peers with better and cheaper products.
There is another key area. Chinese people are not only buying more Western big brand goods, they are also looking for more experience-based consumption such as entertainment, food and beverages, and travel.
While it is true that China’s economy has been slowing, there are many progressive companies that focus beyond top-line growth, on factors such as brand equity, productivity and research & development. These are companies that can still grow relatively rapidly and consolidate the market.
The government’s agenda of lowering the gap between the rich and the poor, grappling with an ageing society and protecting national security is here to stay. Last year’s regulatory shock was about changing the regime curve, while this year it will be more about implementation, so we won’t necessarily see more regulation.
As to the property market, the government has unleashed all kinds of easing measures on both the supply and the demand side. Many cities have relaxed the rules on mortgage requirements, making it easier for people to buy their first or second homes. On the supply side, the government is ensuring projects have enough financing.
This has been one of the biggest hurdles for the Chinese economy. The strict Covid policy created uncertainty for businesses, so they were reluctant to make major investment decisions. For consumers, it lowered both confidence and income expectations, reducing their inclination to buy.
However, the situation now appears to be easing, with the number of days in mandatory quarantine after international travel reduced and more government officials travelling the country and having meetings without facemasks.
I think the government is aware of the damage the policy did to the economy during the second quarter of 2022, and it cannot repeat that. As the market sees a roadmap for easing out of the zero-Covid policy, sentiment should improve – there are already signs of this.
China is not experiencing the high inflation suffered in other regions for several reasons. On the energy side, China depends more on coal, which is cheaper than gas, and there’s plenty of it. In terms of food security, China is self-sufficient in most areas.
China was first into the Covid pandemic and first to emerge from it. The recovery phase from Covid is over and growth is slowing due to the property market, the zero-Covid policy and geopolitical tensions.
When China ends its zero-Covid policy, demand should start to pick up, at which point I believe China would be ready to stomach higher inflation than normal because growth would be more important.
Contrary to widespread perception, China is paying more and more attention to environmental societal and governance (ESG) factors; it’s an area gaining in importance both for companies and in terms of local regulation.
There is pressure from the government to take ESG into account and companies are devoting more resources to it.
However, data collection from international sources is an issue, for example, because of a lack of language skills, so there can be discrepancies between ESG scores and the actual situation in China.
The environmental element of ESG is seen as more important in China than aspects such as female representation in top management. Our teams are working to bring more awareness of the ‘social’ and ‘governance’ concepts in ESG to Chinese companies.
We don’t simply look at a company’s ESG score. Companies that want to improve may not have the resources or someone to guide them. For us, it’s important to identify companies that aspire to adopt better ESG practices and help them achieve that.
ESG should not be regarded as separate from an investment track. That is why we take an integrated, holistic approach. ESG is embedded in every step of our process, from pre-investment screening to research and post-investment monitoring.
This interview is based on a podcast produced by European Pensions