Global Economics

Fund Managers Urge Caution on China


The market is over-crowded with investors and valuations are stretched, analysts warn

China has long been the focus of attention for investors looking for a long-term growth story in emerging markets and specifically in Asia. Although the market has already rallied significantly from recent lows, investors remain generally overweight in this market, citing its economic expansion prospects and optimism over the government's Rmb4 trillion ($586 billion) fiscal stimulus package.

While the consensus is clear that China's economy does hold significant promise, not everyone is convinced it deserves blind faith. And with valuations of China shares rising so rapidly this year, some fund managers are finding it hard to justify the gains.

"There is no doubt that China's economy is strong relative to developed market economies. Strong growth in bank lending, a boom in fixed-asset investment and resilient consumption are painting an attractive picture and encouraging investment in the equity market," says Nick Scott, Hong Kong-based CIO for Asian equities at BlackRock. "However, this must be tempered with a note of caution."

Scott notes that the year-on-year trends in China's economy are clouded somewhat by the base effect of last year's snowstorms and the earthquake in Sichuan. In addition, bank lending, while enormous, has been very short-term. Ultimately, industrial profitability in the export sector is likely to contract and disappoint until there are signs of sustained recovery, beyond the current inventory re-stocking, in Western consumer markets, Scott says.

"Given this, we remain focused on opportunities in Chinese domestic consumption and eschew the exporting industrials," Scott says. "Chinese consumption has shown little sign of slowing substantially and remains particularly strong at the high-end. China's continued strength is a bright spot in the global economy and is providing numerous investment opportunities."

Property remains the key "swing" factor and the next three to six months are crucial, Scott says, adding this market is likely to recover before the export market. If the current wave of transaction growth remains sustainable over the next three to six months, it may signal growth in property investment, which typically lags growth in transactions by six to 10 months, he adds.

BlackRock invests in China primarily through H-shares and red-chips in Hong Kong and Chinese stocks listed in Singapore and the US. Its BGF China fund also makes use of A-share exposure through P-Notes. The fund house also invests in indirect beneficiaries of a Chinese recovery, such as resources stocks in Australia.

Alex Ingham, a London-based emerging markets fund manager at Aviva Investors, believes the long-term bullishness on China is well-deserved. China is, after all, among his favoured markets in Asia. He stresses, however, that the problem lies with valuations.

Many of the stocks exposed to China's fiscal stimulus package—cement, steel, construction, to name a few—have become stretched, says Ingham, who gets his exposure in the market mainly through H-shares in Hong Kong.

Given the huge contraction in global demand, government policy is likely to remain the key short-term driver for markets, says Ayaz Ebrahim, CEO of Halbis Capital Management Asia-Pacific.

"China's ability to stimulate the economy is unparalleled, and data over the last couple of months suggest that government measures are gaining traction. It is understandable, therefore, for managers to be bullish on China," says Ebrahim. "However, it is becoming a crowded trade, and not all companies will benefit from government policy in a sustainable way. It is key, therefore, to look closely at each company's operating model and strategy and to be disciplined in assessing valuations," Ebrahim says.

The extreme stimulus measures being employed by China, and the rapid loan growth in the first quarter of this year, may create risks in the medium-term that investors should be aware of, Ebrahim adds.

Halbis has a number of China strategies to invest in red-chips, H-shares, B-shares and P-chips. For A-shares, Halbis invests in the market through equity-linked instruments and the QFII quota of HSBC Global Asset Management.


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