There has been a lot of turmoil in the Chinese economy and policy announcements about tech, education and the latest saga of the Evergrande property development conglomerate. In such an environment, where are the opportunities, what are the risks and how should investors navigate them?
China has not been dull lately with the Evergrande property developer crisis, crackdowns on business sectors such as tech and video games, continued controversy over its national security treatment of Hong Kong, frictions with India, Australia and the US. And yet, on the flipside, the country continues to open its capital markets to foreign investors.
Western banks are beating a path to mainland China’s affluent middle class. China’s wealth “connect” regime that binds the mainland, Hong Kong and Macao more closely is now live. Banks see big potential in this market.
Given all the above, how should investors approach China? Are the upside risks still worth taking? Should they go with George Soros and be concerned about what could be lost?
While there has been a lot of noise in the system about recent policy announcements and the implementation thereof by Beijing, there are some good reasons to be positive about investing in China, argues Ian Beattie, fund manager of the Nedgroup Investments Global Emerging Markets Equity Fund. Recently, he was a presenter at the annual Global Investments Summit hosted by Nedgroup Investments.
There is huge potential for selected Chinese companies to become world leaders in the same way that some US companies were in the 20th century. By identifying companies that are truly adding value to society and staying in line with the Chinese Government’s requirements, there is real value to be found, Beattie said.
“China actually has a lot of similarities to the way the US was in the early 20th century, where companies with a competitive advantage used that to take market share, eventually becoming global leaders one day. We believe that the Chinese government tends to be rational in their decision making, with a great track record and seldom making mistakes, similar to the Fed – so, in our view, it makes sense not to position your portfolio against their views,” he said.
When investing, think carefully about the business models of investee companies, he said. “Before investing it’s important to ask: Are these companies actually adding value to society and the environment? Or are they in it to turn out profits at the expense of society while casting an illusion over their activities to create the perception of having societal value? These business models are likely not going to be sustainable for very long.”
So, what should one look for?
Beattie advises investors to focus on businesses with a win-win business model, that are working towards the same objectives and goals as the government and the regulators. “The business should also be meeting a genuine need in the market for consumers and applying investment know-how. Invest in businesses that are attractively priced and are generating real economic value for stakeholders, with real operating cash flows and that are able to reinvest in the business,” he said.
In China, there are significant second round benefits to reinvesting in the business as this also pleases the regulators, he said. Beattie said that one such example is TAL Education Group and New Oriental Education which has been hit quite hard recently. Instead, Beattie’s portfolio has been invested in China Education Group, which he says has delivered tangible societal value and has also followed the letter and spirit of the law.
Find the winners in each sector
“There are typically only a few real winners in each industry. Don’t buy the cheap, second-best company or a marginal player as they are unlikely to make consistent returns on capital through the cycle as this is quite difficult - but always keep a lookout for the companies that will likely be the future TSMC’s or Samsung,” Beattie said.
Longi Green is dominating the solar business for example. They are spending significant amounts in capex each year, but this is actually falling as a percentage of sales each year. This makes for a great outlook as operating cash flow and free cash flow as a percentage of sales are actually increasing, resulting in growing margins, he said. Beattie also referenced CATL and Flat Glass as “future winners” following this pattern.