Catherine Yeung
 

Structural and policy reforms have widened the opportunity set in China. Combine this with the inclusion of A-share in the MSCI Index and we believe China should not be overlooked by Australian investors. 

Once upon a time it was said that all roads lead to Rome but today it’s probably more suitable to say they lead to China, both figuratively and literally. The last decade in China has witnessed a meaningful transformation from fixed asset investment towards consumption. Prior to 2008, the economy was dominated by a range of state-owned enterprises such as industrials, banks, energy giants, and telecommunication companies but if you fast forward ten years, 41.5% of the MSCI China Index consists of internet-led businesses and another 9.5% is allocated to consumer discretionary stocks. In contrast, energy, telecommunications and industrials make up only 4-4.6%.1

Today there’s a lot more to Chinese equities than the well-known MSCI China and MSCI Hong Kong indices. In fact China’s domestic A-share market is the second largest stock market in the world. If we look across the Shanghai and Shenzhen Stock Exchanges and Chinext, China is now home to a range of blue chip stocks with well-established business models, strong pricing power and robust cash flows. Many of these companies are now also exploring international markets, expanding product lines and entering new market segments.  For example Midea is a leading whitegoods manufacturer in China offering a diverse range of products product including air conditioners, small appliances, washing machines and refrigerators. It first entered the foreign market in 2007 and has established a strong franchise internationally, especially in Latin America and South East Asia. Today Midea has operations in over 200 countries and is generating over 40% of its revenue overseas.

Broader themes in the market
Innovation: China’s ‘Make in China 2025’ strategy, which encourages Chinese manufacturers to climb the value chain and become more innovative, is a key theme we’re seeing play out in many industries. China has for example the world’s second largest Artificial Intelligence (AI) ecosystem after the US and together they hold over half of all AI patent globally. In the next decade, several opportunities are likely to emerge to the massive growth potential of this trend.

Chinese internet giants have made significant investments in China’s AI industry in recent years, such as opening research facilities worldwide to attract global talents and increased spending in R&D. Tencent in particular, has been widely using AI in targeted advertising on WeChat and game developments.
Traditional industries: There are still many opportunities in well-run durable state-owned enterprises (SoE), particularly in companies that have been reform orientated and implemented self-help measures and capital discipline. A number of old economy names are entering the second year of robust and sustainable earnings, which suggests these companies are being better run and the government’s policies to reduce capacity and excess are having an impact. 

We’re also seeing industries such as coal, steel and cement going through different stages of de-capacity, improving the supply/demand dynamics of their respective products. These industries are also amongst the biggest culprits for non-performing loans on bank’s balance sheets, so their improvements coupled with stricter loan requirements is helping to improve non-performing loan formation.

In the cement sector, Anhui Conch Cement is a beneficiary from supply side reform, which has helped to increase the selling price of the company’s products and improve overall profitability. It is also the lowest cost producer in the sector with a solid balance sheet.

Changing face of labour: Over seven million college graduates join the country’s labour market each year. This huge supply has produced a large pool of highly educated but relatively low-cost engineers, which forms a solid base for China to evolve from the world’s factory into an innovation powerhouse in the years ahead. This also supports the thesis of an expanding middle class in China. 

Structural reform is good news for investors looking offshore to China
It was said that Rome wasn’t built in a day but every hour they were laying bricks. Perhaps we should think of China like this - the Government is laying the foundations for future growth. While investors may at times question the Chinese one-party political model, the fact is that what the Government has achieved is significant, particularly on the back of more open-market reforms that actually started in 1978. 

The Government has detailed five-year plans outlining policy goals and a very strong track record of meeting those targets. Progress in areas such as SoE reforms, supply side reforms, environmental protection and anti-corruption initiatives from a few years ago, have all stemmed from a clear policy stance and execution. These reforms have widened the opportunity set, making China more attractive to investors and should be considered when making an allocation to offshore markets.


1Index data as at 28 February 2018.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets.

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise. 

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