China is facing a set of growth-related challenges. The impact of the trade conflict with the U.S. is taking its toll as well as demographic issues. At the same time, new investment opportunities in China show, knows May Ling Wee, China equities manager at Janus Henderson.
AsiaFundManagers.com: What has been the impact of the trade conflict on the China’s growth so far?
May Ling Wee: News flow about the relationship between the U.S. and China is in a constant state of flux; we would be hazarding a guess as to the final outcome. As it currently stands, our expectations for any near-term trade deal are low. The trade war between China and the U.S. is not just about trade, but is also a battle for technological, economic superiority, and geopolitical influence. We therefore expect this ‘war’ to be long-lasting, with no easy resolution.
The first and most direct impact on China has been on domestic business owners’ confidence and therefore their willingness to invest. We have already seen Chinese trade numbers take a hit; total trade in China has weakened whereas trade data from alternate supplying countries, such as Vietnam and Taiwan’s exports into the U.S., have been more resilient.
The Chinese manufacturing sector has also suffered. Investments in electronics equipment and light industry manufacturing have barely grown year to date; a substantial change compared to the consistent single-digit to low-teens growth over the past few years. China is a key part of the global supply chain for electronics, an area where both private domestic and foreign investment has grown consistently. The relocation of the manufacture of lower-value goods to nearby Asian countries had already started before the onslaught of the trade wars, as China had already lost its advantage in low cost, lower-skilled labour to countries such as Vietnam, Cambodia and Indonesia. The process of relocation will continue, if not accelerate as every business owner evaluates the benefits of diversifying their production bases.
China’s self-reliance and technology independence will harden
AsiaFundManagers.com: How dependent is China on the USA when it comes to technology?
May Ling Wee: The crux of the trade war is on technological supremacy bringing about an economic (through productivity gains) and geopolitical advantage. Tariffs and non-tariff measures will only harden China’s resolve for self-reliance and technology independence. The U.S. has many non-trade levers to pull. A key weak point for China is its dependence on foreign technology, especially semiconductors.
Semiconductors are a vital component used across many industries today and being short of just one component could mean a system failure for the end product. China will be even more determined to move towards ensuring it supports and develops its own domestic companies to be competitive and self-sufficient in the technology supply chain. As a result, we expect to see a lot more spending and support for research and development (R&D) by Chinese technology and industrial companies to ensure self-sufficiency.
AsiaFundManagers.com: China pledged easier market access for foreign investors. Which recent developments do you see?
May Ling Wee: China has been protecting its domestic industries by requiring foreign companies to operate through joint ventures with local partners such as in the automobile and life insurance industries. But, China does not want to be perceived as isolationist and wants to continue to be a significant player in the global trade of goods and services.
China investments: Automotive and financial industries opening up
May Ling Wee: As a result we have seen a recent acceleration in foreign ownership deregulation in the Chinese automotive and financial industries. The lifting of restrictions should allow foreign insurers, securities companies and asset managers in China to fully own their operations and expand geographically, bringing best practice to the financial industry, foreign expertise, improved product range and healthier competition.
AsiaFundManagers.com: China’s rapid growth in recent decades has resulted in some negative impacts on society and the environment. Do you consider environmental, social and governance (ESG) factors in your portfolios?
May Ling Wee: The investment case in China is complex. In terms of the environment, China has put a lot of resources into renewable energy after years of investment in heavy and extractive industries, textiles and electronics manufacturing. It is now a richer economy where its people demand a better living environment. To ensure sustainable growth, Chinese policy has been encouraging through subsidies, investments in renewable sources of energy. It is demanding higher standards of environmental enforcement in its heavy industrial sector – a move that disqualifies many smaller enterprises without the scale and resources to invest in these environmental facilities.
We have found means to participate in such opportunities. In the natural gas distribution industry in China, the government’s ‘Battle for Blue Sky’ initiative (a three-year plan for cleaner air) and switching coal for gas effort in North China will continue to drive gas demand growth for a sustained period of time. But investing solely in areas that the government has identified as focus points is not always good enough. In many instances, subsidies and efforts to promote an industry often mean that a lot of private and public capital is drawn in. This was evident in the wind, solar and electric vehicle industries, which ultimately led to excess capacity and little pricing power for industry participants.
AsiaFundManagers.com: China is facing a demographic decline. This brings challenges on one side, but also opens up investment opportunities. Which do you see?
May Ling Wee: We cannot deny that China’s demographic decline will be a growing challenge over time. The working age cohort (15-64 year olds) is no longer growing while the 65+ age group continues to rise. Nevertheless, China still has a large number of new workers entering the workforce each year. In the manufacturing industries, we focus on companies that continue to invest in R&D to increase automation and streamline production processes, raise productivity and reduce the number of workers required for production lines.
Life insurance, wealth management, travel and consumer sectors to watch
May Ling Wee: However, we believe that the ageing population’s collective wealth creates opportunities in service sectors such as life insurance, wealth management and travel. Insurance penetration is low in China relative to GDP, the protection gap is large. For the maturing workforce and China’s many entrepreneurs, the desire for wealth protection and assets growth become stronger as this group considers the generational transfer of wealth as well as retirement.
AsiaFundManagers.com: In your view, which sectors are currently offering the most attractive investment opportunities?
May Ling Wee: We continue to like the consumer segment in China. This includes not just consumer staples and the discretionary segment, but also broader consumer-facing areas such as life insurance, healthcare, autos, and the internet. The trade war and further tariffs will undoubtedly have a negative impact on both consumer and business sentiment. However, consumption demand is relatively more stable and less volatile than corporate and business demand. This is due to lower ticket prices and affordability of consumer products, as well as the ability of consumer companies to upgrade and adjust their product offering.
We are seeing rising penetration and adoption rates as well as market share gains by leading companies in areas such as online travel, ecommerce and after school tutoring. This is occurring despite a weaker macroeconomic environment. We also like the Macau gaming sector as cash-flow generation in this space is strong and mass gaming (a large proportion of profits for some service providers) is showing resilience especially given the better infrastructure access for mainlanders into Macau.
AsiaFundManagers.com: Thank you very much for the interview.
May Ling Wee
Chinese equities manager
Janus Henderson Investors