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China A shares and the rise of the Chinese consumer

Chinese equities plummeted in 2018. We talked to Donald Amstad, Chief Operating Officer and Head of Investment Specialists Asia Pacific at Aberdeen Standard Investment about the sentiment for Chinese equities and the inclusion of China A shares.

AsiaFundManagers.com: Last year, Chinese stocks slumped sharply. What were the reasons for this?

Don Amstad: It was due to three factors: the slowing of the economy, a rise in bankruptcies, and the trade dispute. There are many different markets for shares issued by Chinese companies. The most famous is the ADR Market in New York, which is where you have companies like Alibaba and Baidu listed. Then you have the Hong Kong Market and H Shares, and some special company shares for companies like Tencent. Most investors around the world have exposure to these ADRs and H shares. What is very new is this opening of the China A Share smarket. Fully 80% of the turnover in A Share market comes from retail investors in China. These investors are driven by sentiment.

China A Shares down 33%

If you speak to people in China, sentiment is terrible because the economy is slowing down and bankruptcies are going up. This is very new for the Chinese economy. Of course, we have the trade dispute between China and the United States. Last year, because of this relentless bad news, retail investors sold shares and they sold very aggressively. So, the A Share market was down about 33% last year.

China A Shares dropped 33% in 2018
China A Shares dropped 33% in 2018. Source: Bloomberg

AsiaFundManagers.com: So, what is the likelihood of the situation improving for Chinese equities in 2019?

Don Amstad: At Aberdeen Standard Investments, we firmly believe that there will be a trade agreement between the US and China in 2019, because both sides need it. President Xi needs it, because if President Trump goes full tariff, then that’s going to slow the economy even more. Trump, we understand, now spends a lot of time watching television. We know that one of the indicators he looks at, to see whether he’s doing a good job or not, is the stock market. He must understand that if he doesn’t do a trade deal with China, then the US stock market is vulnerable and is going to fall. And subsequently his chances of getting re-elected in 2020 are going to be lower.

AsiaFundManagers.com: This conflict is not only about the trade deficit. It is about more difficult issues, such as intellectual property rights, technology, and leadership in the future. Do you think this is something that can be resolved within a few weeks?

Don Amstad: Absolutely not. Any deal that is announced may talk about tariffs, but this longer-term competition between the United States and China is something that is absolutely not going to go away. It’s true that the Chinese request intellectual property from companies setting up to do business in China. That’s just part of their negotiation and bargaining process. It’s the price companies pay to get access to a market of 1.3 billion consumers. If you want to play, you have to play by Chinese rules. I think there is a lot of growing-up that needs to be done, and understanding that needs to take place. When in Rome, do as the Romans do.

China wants a seat at the table

AsiaFundManagers.com: Will there be an agreement on this more difficult aspect between the two sides?

Don Amstad: There is so much intellectual property coming out of China now. The government does have a vested interest in agreeing to a set of rules. Part of the problem is that China didn’t write the rules that were established at the end of WWII by the Bretton Woods conference and all these other agreements. Now China is such a big player in the global economy. I think everyone agrees that the rules need to be rewritten, and China wants a seat at the table when the rulebook is rewritten. That takes time, and this trade dispute is probably not even a chapter in the book about the future of Chinese relations with the United States and the rest of the world.

With accessibility comes index inclusion

AsiaFundManagers.com: MSCI has recently announced that it will increase the percentage of Chinese equities in its indices. What does this mean for the capital market?

Don Amstad: The announcement of MSCI of A Share index inclusion is incredibly important. By the Hong Kong Stock Connect System, anyone who has a bank account in Hong Kong can now buy and sell any stock they please in China. And if you want to sell one, you can take the money straight out again. There are no capital controls for foreigners through the Hong Kong stock connect. MSCI now deem the A Share market to be accessible, and with accessibility comes index inclusion.

AsiaFundManagers.com: What does the growing inclusion of Chinese stocks with the MSCI and other indexes mean? How do I position myself as an investor with that in mind?

Don Amstad: Nowadays, between 70% and 80% of the money that goes into emerging market equity funds is passive. It goes in through ETFs and other structures. $1.9 trillion are invested against the MSCI emerging market equity index. So, you can do the maths very quickly as to how much is going to come in. One idea is to buy now before all this passive money starts to come in. We think it’s a very interesting opportunity to buy now, especially as the market was so badly beaten up last year.

Financial quality in China will become very expensive

AsiaFundManagers.com: The Chinese economy is changing. Where are new investment opportunities emerging in China?

Don Amstad: I’m sure people in European cities are now familiar with the concept of the Chinese tourist. When it comes to shoes, handbags, clothes, luggage, and consumer goods, they know what the best quality is and are happy to pay a high price for the best. It’s interesting that when it comes to investments, Chinese investors don’t have a clue what financial quality is. They don’t understand what a good quality stock is. The Chinese are very smart and they learn very quickly. My point would be that when Chinese investors wake up and understand what financial quality is, the financial quality in China will become very expensive. Right now there is a great opportunity to buy quality incredibly inexpensively in China.

China A Shares PE historical low
China A Shares PE historical low. Source: Bloomberg

AsiaFundManagers.com: How do you define quality in a state-regulated emerging market like China?

Don Amstad: I think quality in China will look like quality anywhere else. Great companies run by great people, with great balance sheets, great products, some sort of a moat around the business, and a unique competitive advantage. Companies with a very high standard of governance. When you ask someone at Aberdeen Standard Investments what financial quality is, it’s all that, everything Warren Buffet believes in basically.

The treatment of minority shareholders is incredibly important

We ask one very important additional question, which is, “Do we trust the management of the company to treat minority shareholders fairly?” When we invest in companies, we don’t want to be a controlling investor. We don’t have directors that we want the company to put on the board or anything like that. Aberdeen wants to be perceived as patient suppliers of long-term capital. We want to help turn good companies into great companies, and we understand that that takes time. This treatment of minority shareholders is incredibly important, because if you treat them well, the market will reward you with a higher PE, and all shareholders gain equally.

AsiaFundManagers.com: Who will be tomorrow’s winners as the Chinese economy undergoes structural change?

Don Amstad: China is undergoing enormous change away from export-led growth. Net exports have barely contributed to Chinese growth for the last 10 years, and the labour force is shrinking. In 2017 a net 4 million workers left the work force. Low-end manufacturing is already leaving China and going to Vietnam, the Philippines, Bangladesh, Malaysia, or Thailand. The winners are not going to be in manufacturing or export. It’s going to be domestic demand-led. It’s going to be consumer-led. It’s going to be services-led.

Take travel, for example. Under Mao, they weren’t allowed to travel within their own country or overseas, so tourism is now exploding both domestically and internationally. Ten years ago, 5 million Chinese went overseas for a holiday. Last year the number was 135 million. Healthcare is also huge. As income is rising, people want to feel well, live longer and look beautiful, as we all do. The future in China is about the consumer. It’s no longer about companies making widgets to export to the United States.

AsiaFundManagers.com: Don Amstad, thank you very much for the interview.

About Donald Amstad  

Don Amstad of Aberdeen Standard Investments about China A Shares
Don Amstad of Aberdeen Standard Investments about China A Shares

Donald Amstad is Chief Operating Officer, Distribution Asia-Pacific; Head of Investment Specialists – Asia Pacific; and fixed income investment specialist at Aberdeen Standard Investments. He is based in Singapore, where he joined the company in March 2007 as Head of Fixed Income Asia-Pacific.

Donald started his career in London at Nomura (1983-1987) before moving on to JPMorgan (1987-2001), Bank of America (2001-2004) and JPMorgan Asset Management (2004-2007). He has over 34 years experience in fixed income markets on both the sell and buy sides, in a variety of roles covering distribution, trading, syndicate and fund management. Donald Amstad has lived and worked in Asia for more than 20 years in both Japan and Singapore.

Donald holds a BA (Hons) in PPE from Trinity College Oxford.