On Friday China will celebrate 100 years since the first meeting of the Chinese Communist Party at a time when companies and investors are rethinking their approach to the country.
Undoubtedly many tribulations have dogged the country, from famines to trade wars, pandemics and the current reports about the treatment of Uighur Muslims, the party has been pivotal to China’s economic transformation and cultivating a Silicon Valley-like entrepreneurial culture that has given rise to some of the world’s biggest companies.
Just past the midway point of 2021, the country’s economy is at an expected turning point, with the rebound from the Covid-19 shock seen to have reached its limits.
But Scottish Mortgage Investment Trust (LSE:SMT) PLC, the UK’s largest investment trust, has been growing its exposure to China grew over the past year, with four of its top 10 largest positions being Chinese companies: digital giant Tencent Holdings Limited (HKG:0700), electric vehicle maker NIO Inc (NYSE:NIO), ecommerce platform Alibaba Group (NYSE:BABA) and local services platform Meituan, respectively.
SMIT fund manager Tom Slater recently said that “the pace of innovation at scale in China now exceeds anything we can find in the rest of the world” and he and his team “think there are still some really big opportunities in that market”.
Tencent, until recently its biggest holding, recently agreed a takeover of London-listed video games producer Sumo Group PLC (AIM:SUMO) for more than £900m, with Slater highlighting that Tencent, not only has made big progress in its core business but also built a portfolio of investments in “all sorts of different exciting companies around the world which has been a hugely value creative experience” and now worth close to $200bn on its own.
Another aspects of China that is exciting Slater and his team is the next wave of entrepreneurs “coming through and able to innovate at real scale”, such as ByteDance, the owners of the TikTok app that now dominates China’s online advertising landscape less than a decade after its founding, and Pinduoduo, an agriculture-focused online platform, which was founded in 2015 and has already overtaken Alibaba’s audience size in online commerce with more than 750m users.
SMT added to most of its Chinese positions through the course of the year as well as taking new holdings in these other “breakthrough companies” as they emerge.
Like many major Western governments and companies, which continue to grapple with China’s growth, influence and controversies, Dzmitry Lipski, head of fund research at Interactive Investor, said investors were also pondering whether they should “avoid, invest, or engage”.
“The Chinese Communist Party is one of the world’s most powerful institutions. The policy choices and actions of this opaque political organisation, and concerns about human rights, means that investors looking for exposure to China may well want to focus on fund management groups that take engagement and stewardship issues seriously,” Lipski said.
“We think that for investors, this engagement approach is more realistic than the idea of avoiding China – global supply chains mean that we all have exposure to China, both as consumers and investors.”
As well as SMT, he also favours Fidelity China Special Situations Investment Trust PLC as another recommended specialist China-focussed collective investment vehicle.
Fidelity China, says Lipski, “believe that that better governed companies make better investments – again, engagement here is key.”
There is also merit in taking a diversified approach to China as part of a broader way to access Asian markets, as Lipski adds.
Another fund he likes is Pacific Assets Trust PLC (LON:PAC), which invests within an ethical framework and has around 4% of its assets in China and 8% in Hong Kong.
As well as a strong emphasis on ‘quality’ businesses that can perform well over the business cycle, companies are classified into one of three sustainability sectors: sustainable goods and services, responsible finance, and required infrastructure.
His colleague Tom Bailey, who specialises in exchange-traded funds, says with China the world’s second largest economy and, as SMT observes, home to some of the world’s leading and most innovative companies, Chinese stocks are “something few investors can now ignore”.
However, he says similarly the influence of the Communist Party cannot be ignored either especially as it has begun a so-called ‘tech crackdown’ after years of turning a blind eye to Chinese companies using complex legal loopholes to list on foreign stock exchanges.
SMT favourites Alibaba and Meituan came under the Beijing cosh and there was a cybersecurity investigation into ride-hailing app Didi.
“The Communist Party’s goals have changed,” Bailey says. “China’s leader, Xi Jinping has decried the ‘disorderly expansion of capital’. For various reasons, China seems to no longer be keen on its companies listing on foreign exchanges. More broadly, some analysts think the party is trying to reassert dominance in the face of the growing power of Chinese tech firms.”
This has led to increased regulations for Chinese shares tyring to list on foreign exchanges, including seeking approval from Beijing.
“As a result, markets are now fearful of the future of the US-listed Chinese shares,” he adds.
“For all the risks of investing in China, there is no denying its increasingly important role in the global economy. It is home to some of the world’s leading companies as well as a huge consumer market. For many investors, not having any exposure would be unthinkable.”
The biggest China ETF is the iShares MSCI China ETF, at almost US$6.8bn, with the index being tracked offering quite a diversified exposure to the Chinese market though holding a lot of individual stocks.
As the ETF Database website says, which could make it potentially more attractive to investors with a long time horizon, while also having a big allocation to financials and large cap stocks, like many other China ETFs.
Those looking to establish a position in smaller Chinese firms may prefer the iShares MSCI China Small-Cap ETF (ECNS), which is US$100mln in size.
The Emerging Markts Internet & Ecommerce ETF is a more diverse ETF with a strong weighting to China among its wider emerging markets theme, with the largest holdings currently all Chinese: Meituan, Alibaba Group, Punduoduo, Tencent and Jd.Com.
“Put simply, it aims to give you exposure to the Ubers, Deliveroos, Amazons and Etsys of the world’s developing economies. This is a play on both the rise of the middle class in emerging markets, with their increased spending power, alongside the growth of digital companies within the region,” says Bailey.