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China A: Going mainstream, going strong

Shanghai, China

China has the world’s second-largest economy and second-largest stock market, with a market cap above $10 trillion. Yet A-shares account for just 0.6% of the MSCI All Countries World Index. In the past, China’s onshore market was hard for global investors to access but it has opened up and liberalised considerably in recent years. Reflecting this progress, index providers are now adding A-shares incrementally to their global benchmarks. A guest commentary by Nicolas Yeo, Head of Equities (China/Hong Kong), Aberdeen Standard Investments.

Why invest in China?

The answer is growth. China’s economy is increasingly self-reliant, its fortunes driven by domestic factors – namely Chinese consumers. Its capital markets continued to function relatively well last year despite Covid-19 and geopolitical tensions. Domestic tourism has rebounded, while domestic consumption at the premium end is recovering well. This earlier economic restart affords investors greater clarity on the outlook for Chinese company earnings.

Of course, one unknown remains how US-China tensions will evolve under a Biden US presidency. If we see continued US-led moves to restrict Chinese access to technology, that could slow China’s economic catch-up. Yet, China’s assertiveness in managing tensions with the US is underpinned by changes to its own economic model. It is becoming far more self-reliant, its fortunes driven more by domestic factors – namely the burgeoning Chinese consumer.

Stimulating domestic demand is a key plank in re-balancing its economy towards consumption and services, even as it remains open to international participation. Economists within our Research Institute forecast that China’s figure for nominal gross domestic product (GDP) will overtake that of the US by 2035.

The A-share market, key drivers and improved access

The MSCI China A Onshore Index was among the best performing in the world in 2020, driving its market cap through the $10 trillion barrier for the first time (Bloomberg January 2021). The market is deep and liquid with more than 3,800 A-shares, including companies in fast-growing new-economy sectors not readily accessible offshore. It offers the most diverse way to access China’s growth.

China’s world-leading rally last year was driven by both domestic and foreign investors. Since Stock Connect launched in 2014, A-shares have attracted $170 billion in net inflows from overseas. It created a trading loop linking the exchanges of Hong Kong with Shanghai and Shenzhen, and broadly, this addressed foreign investor concerns about lack of direct market access. The admission of A-shares into mainstream benchmarks should see further capital flows from foreign institutions.

In our view, the key to unlocking shareholder value is identifying companies in line to benefit. We believe higher disposable incomes will spur demand for health-care products, wealth management services, insurance and luxury goods and services. Structural growth drivers such as the adoption of renewable energy, cloud applications, 5G, e-commerce and artificial intelligence also remain intact. Renewable energy has never been cheaper, and China dominates the global renewable and battery supply chains. We think the industry has a bright future.

Furthermore, A-share trading remains driven by retail investors influenced more by news headlines than company fundamentals. This creates a fertile ground for active stock-pickers as mis-pricings are common.

Chinese companies and ESG

Despite the growing case for China A-shares, sustainable investing in Chinese companies is a question often raised by potential foreign investors. However, today Chinese companies are engaging with asset managers more closely than ever. Increasingly they are aware of their carbon footprint and realising that by implementing sustainable practices, they can improve brand perception, customer loyalty and, ultimately, share price.

They are also engaging on social factors, such as how they interact with employees, vendors and society. Firms able to showcase how they safeguard customer data, prioritise environmental sustainability, foster a good staff culture and maintain standards among their supply chain will resonate with customers. That will drive profitability, and consequently investor interest.

Nicholas Yeo_Aberdeen
Nicholas Yeo, Head of Equities (China/Hong Kong), Aberdeen Standard Investments

As many companies in China are now willing to engage on all aspects of running and building a business, this has given us the confidence to increase our exposures in China. We believe selecting companies with strong ESG (environmental, social and governance) standards improves our chances of investing in long-term winners and avoiding loss-making corporate failures and scandals.

Undoubtedly, China’s capital markets have continued to function extremely well despite a challenging year for most markets. Increasing foreign participation, underpinned by structural growth opportunities connected to a growing middle class, supports our positive outlook on this market and highlights that investors not exposed to China risk missing out on its strong growth potential.

This commentary first appear on AberdeenStandard.com