What is to blame for the fall in China's stock markets?
Robin Parbrook: This fall is not due to the pandemic or even disappointing economic growth. This crisis is political and linked to regulatory risk. Most of the decline has been in the last two or three months, when China started to explain how it wanted to deal with the operation of the education sector. In the end, China turned most of the education sector into a not-for-profit sector, a warning sign for investors about regulatory risk in China.
The speed with which China has regulated many important sectors has come as a great surprise. The internet sector, in particular, is of most interest to US investors because many of its stocks are listed in the US. But this is also true for the insurance sector, the health sector and the real estate sector. There is talk of a major, global structural change in the market.
What should investors expect?
It's hard to say, because we don't really know what will happen next. But the declines are justified because we have experienced a more draconian and extensive regulatory climate than we thought.
However, it should be remembered that Chinese equities experienced sharp swings in February and March, when there was talk of bubble-like valuations, mainly in the internet and biotech sectors. Even without the current circumstances, these sectors already seemed very vulnerable to the risk of a correction.
How can foreign investors invest, given the current climate in China?
Investors can invest in Western companies that have strong exposure to China, such as Louis Vuitton, Nike or Adidas. They can also get their exposure to China through Hong Kong Special Administrative Region (SAR) stocks listed on the Hong Kong Stock Exchange. Or through shares on the Shenzhen or Shanghai stock exchanges. Or by buying shares in multinational companies with operations in China, such as Schindler or Kone.
What are the consequences of developments in China for investment in the rest of Asia?
There is talk of a big risk in China. It's not cyclical or a noise, it's structural. This means that investors need to think carefully about how much they want to invest in China. When you turn the most dynamic part of your economy--your internet stocks and some of your healthcare names--into quasi-public companies, there's nothing you can do, it loses its appeal.
So the first reaction was to move the money to other markets in the region. In particular, capital has been flowing to India. The bigger question, which we don't know much about, is whether investors are starting to question whether it is necessary to keep so much capital in Asia or in emerging markets in general. China is by far the largest in the emerging market indexes, and investors should be able to start reducing their exposure to Asia and emerging markets.
We haven't seen it yet, and I think we will now, but there is an expectation that capital will leave China. Some investors may look to smaller ASEAN markets, such as South Korea and Taiwan, the most liquid markets in the region.
Can an investor still afford to be invested in China?
If you assume that an investor is investing in large multinationals, they will have a position in China. An investor will always be active in China. You simply cannot snub China. The question is whether you should have a large strategic allocation to Chinese stocks.
There are some fantastic companies in China that are generally unaffected by the regulatory risk of consumer companies. There are some export companies, some technology companies that are not at the centre of what's happening now. But should an international investor, or a US-based investor, hold a significant strategic asset allocation in Chinese companies? Probably not, because there is not a lot of interest in large Chinese companies, banks, insurance companies. Perhaps there is in some internet companies when you are setting common welfare goals, dual circulation policy, or government interventionism.
The beta--the measure of the volatility of the systemic risk of a portfolio stock compared to the market as a whole--of China is probably relatively lower today. So buying an index fund in China does not make much sense. On the other hand, there are many opportunities because of the inefficiency of the market. What I would say is that if you want to buy a good active fund, you should not invest too much. Because the risks, which have always existed, have increased significantly on the regulatory side.
This story was first published in French on Paperjam. It has been translated and edited for Delano.