Liontrust Asia Income
China’s 70th anniversary: communism, capitalism and its watershed moment
This e-publication allows users to access additional links and download PDF collateral associated with this publication’s content. It can be viewed as double page spreads or single pages. For mobile devices, please use the zoom function (available from the tab at the base of the page) to optimise the display size.
Page turn ability from all the page corners
Open / close menu
Menu of pages
Use green buttons to download PDFs and link to external pages
Mobile single page view, with Tab open
Tablet in Landscape view shows double page view with menu of pages and Tab open
Tablet in portrait view shows single page view with Tab closed
How to use
2 - LIONTRUST: China
The 70th anniversary of the founding of the People’s Republic of China is an historic landmark and comes at a potentially pivotal moment for the country. China has enjoyed years of rapid economic growth to become the second largest economy in the world but there are now concerns about its pace of future development, the country’s debt burden and the trade wars with the US, as well as potential political and military conflicts.
The economy has recorded its slowest pace of growth for three decades but this can be seen as an opportunity rather than a reason to ignore China, with the Liontrust Asia team arguing this deceleration is part of the transition to more sustainable economic growth. China currently only accounts for 3.4% of the MSCI AC World Index, but this is expected to increase significantly over the next few years.
In this digital booklet, the Liontrust Asia team evaluates how China may successfully navigate this watershed and which sectors and companies are likely to be the winners and losers from the transition. You can also read the latest insights and views on investing in the country, its debt burden and trade wars.
LIONTRUST: China - 3
Communism, capitalism and China’s watershed moment
Seventy years since the establishment of the People’s Republic of China and four decades after Chairman Mao’s death, China is at a watershed both politically and economically.
Politically, China is now finding its place on a global stage as an equal, rather than adhering to Deng Xiaoping’s dictum to ‘hide your strength, bide your time’. We hear about this shift daily; Donald Trump’s tariffs (and relentless talk of his elusive ‘deal’) dominate headlines currently, but China’s position within the Asian sphere of influence and role in global security concerns also continue to garner attention. Hong Kong’s ongoing protests put more scrutiny on a country adjusting to its new, hopefully more mature, status. As China evolves politically, we think events will continue to impact investors’ perceptions, but should not be allowed to obscure the extraordinary economic transformation that is also underway. China is trying to progress from its role as a debt-funded, low-end manufacturer to a more service-driven country with slower but more sustainable growth.
These changes should provide many investment opportunities, but there will inevitably also be some significant losers along the way. To find the former while avoiding the latter, it is necessary to understand the internal dynamics of China’s evolving economy.
Those who look only at aggregate trends may fail to understand the more nuanced situation playing out, with the IMF predicting 6.2% growth for China in 2019, the slowest for the best part of three decades. A cursory assessment might therefore lead you to conclude that – although China’s capital markets are more open and credible than at any time since the Shanghai stockmarket reopened in 1990 – its economic surge is running out of steam, dragging the investment opportunity down with it.
We think this viewpoint is misguided. As the Chinese proverb says: “You can’t judge a person by appearance, just as you can’t measure the sea with a pint pot”. China now presents attractive investment opportunities precisely because it is moving away from the inefficient and unsustainable growth-at-any-cost of the past.
Economic slowdown goes hand-in-hand with rebalancing
China Real GDP Growth
Source: Liontrust, World Bank World Development Indicators
We both expect and hope that China’s economy slows more in the coming years. Such deceleration is a necessary condition for us to remain positive about the country’s longer-term prospects, which we think remain bright. This is especially striking when contrasted with the gloom that engulfs much of the developed world (where extraordinary monetary policies are failing to maintain growth above 2%).
The reality is that China has grown at levels that are not sustainable. Double-digit GDP growth, often supported by cheap lending to inefficient areas of the economy, is not something that we want to continue. While China’s policies helped it to elevate more people out of extreme poverty than anywhere else in the world (850 million according to the World Bank), this has led to imbalances which now need to be addressed. Encouragingly for investors such as us, the Chinese authorities have shown acceptance of this situation, gradually reducing the annual GDP growth target to 6.5% for the latest five-year economic plan, covering 2016-2020 while prioritising more sustainable growth. This growth, although lower, is still very high by global standards. China’s position as the regional growth engine remains intact.
4 - LIONTRUST: China
China’s growth still very impressive by international standards
Real GDP growth (icons scaled by % of world GDP)
Source: Liontrust, IMF. 2019 and 2020 GDP figures are forecasts
China’s appeal to us as an investment destination rests on its ability to manage these competing demands of economic reform and economic growth. While slowly improving, overcapacity persists in some ‘old economy’ capital intensive industries such as steel, cement and industrials. To-date these have often kept alive through relentless refinancing of state-owned bank loans which, one day, will have to be classified as non-performing.
Reducing reliance on heavy industry
Chinese GDP compositon
Source: Liontrust, World Bank World Development Indicators. Agriculture, forestry, and fishing, value added; Industry (including construction), value added (% of GDP); Services, value added
LIONTRUST: China - 5
China also needs to wean itself off export-centric growth. It has made some progress here, reducing exports from 36% of GDP in 2006 to 20% in 2018.
Weaning itself off export-centric growth
China exports of goods and services (% of GDP)
Source: Liontrust, World Bank World Development Indicators
Although such a transition requires the economy to decelerate, we believe the investment opportunity is expanding for those who are able to differentiate between the companies that will benefit from the economic transition and those that stand to suffer. There should be significant numbers within the former category as a more domestic, services-led economy emerges. Domestic consumption as a whole should grow to account for a rising proportion of demand.
Rising consumption emblematic of China’s economic transition
Source: Liontrust, World Bank World Development Indicators. Households and NPISHs Final consumption expenditure (current US$)
6 - LIONTRUST: China
As China’s economy moves to a less aggressive growth phase, we also believe that companies will begin to take more considered capital allocation decisions – investing for growth when appropriate while hopefully showing more inclination to return excess cash to shareholders. On aggregate, we expect free cash flow – cash generated by a company’s operations once capital expenditure needs are accounted for – to increase as past years’ heavy investments begin to mature. This will mean more cash is available to be returned to shareholders, which is already providing ample opportunities for income investors given the country’s improving dividend culture.
For many people, the long-term investment opportunities arising from China’s transition will have been soured by Donald Trump’s determination to engage in a destructive Trade War. While this will indeed hamper economic transition, it will not negate it. We expect there to be increased stimulus from China, and hope that it will remain sensible and targeted at areas which will benefit the economy over the longer term. So far, this has been the case, with sensible infrastructure projects, tax cuts to aid the consumer, and relatively little property stimulus executed. Areas such as these and the accelerated roll-out of 5G plans are giving companies in those areas a significant boost that we think could continue for some time.
While politics will continue to shape some of China’s development, we think the overall ramifications on the region should be manageable. We are finding the number of investment opportunities are rising for discerning investors, and are confident that China’s progress will not be thwarted any time soon.
LIONTRUST: China - 7
People’s Liberation Army enters Beijing (then known as Beiping) during the Chinese civil war between the Communist Party of China and the Nationalist Party.
1 Oct, 1949
Mao Zedong declares the founding of the People’s Republic of China. The Nationalists head to Taiwan.
1953 – 1957
First five-year plan for China’s economy. The Communist Party of China will issue a new five year economic and social development plan every five years.
1958 – early 1960s
Great Leap Forward - Mao’s five year programme to accelerate industrialisation, moving away from an agrarian economy by way to forced collectivisation of farming. Largely viewed as disastrous, the subsequent famine is estimated to have cost tens of millions of deaths.
Cultural Revolution. A decade-long movement to purge capitalist ideas and consolidate Mao’s power. The destruction of ‘four olds’ was targeted: old ideas, old customs, old habits and old culture, caused mass social and economic upheaval
Ping Pong Diplomacy marks a thawing in Sino-American relations
Nixon visits China, the first US President to visit the People’s Republic of China.
70 years of the People’s Republic of China
Mao Zedong dies.
Gaige Kaifang – “reform & opening”. Deng Xiaoping, begins reforms to move away from centrally-planned command economy. “Black cat, white cat, what does it matter what colour the cat is as long as it catches mice?”
Diplomatic relations established with US.
One Child Policy. Following softer efforts to curb population growth, including encouragement of late marriage and a two child limit, the one child policy was applied for over 30 years. Exceptions were made for certain minorities and in rural areas (where the first child was female) but population growth slowed dramatically and became skewed towards males.
8 - LIONTRUST: China
China joins World Trade Organisation
Beijing hosts Olympic Games.
Xi Jinping becomes President of the People’s Republic of China.
Made in China 2025,” a plan announced in 2015 to upgrade and modernize China’s manufacturing in 10 key sectors through extensive government assistance in order to make China a major global player in these sectors.
Xi Jinping changes constitution, paving way for him to be “leader for life”
Communist Party votes enshrine Xi Jinping’s name and ideology in its constitution, elevating him to the level as founder Mao Zedong.
November: Closed for 50 years since the civil war, the Shanghai Stock Exchange reopens.
December: Shenzhen Stock Exchange established.
Qualified Foreign Institutional Investor (QFII) programme allows select instructional investors to own A shares (USD transactions).
RMB Qualified Foreign Institutional Investor (RQFII) programme
MSCI adds China A Shares to 2014 review list.
June: MSCI rejects inclusion of Chinese A shares at 1st consultation.
November: Shanghai Connect launched
MSCI rejects inclusion of Chinese A shares at 2nd consultation.
June: MSCI rejects inclusion of Chinese A shares at 3rd consultation.
August: Shenzhen Connect launched
4th consultation sees MSCI announces inclusion of China A shares at. MSCI finds evidence of “ongoing improvements in China’s market accessibility conditions”.
June: A Shares included in MSCI indices for first time (at 2.5% inclusion factor).
September: A shares inclusion factor increased to 5%.
May: A shares inclusion factor increased to 10%
June: Huatai Securities becomes first company raising money on new Shanghai-London Stock Connect. This new cross-listing mechanism allows international investors to buy A shares via the London market and London-listed companies to access Chinese investors.
August: A shares inclusion factor increased to 15%.
September: Investment quota limits removed from RFQII scheme.
November: A shares inclusion factor increased to 20% following “overwhelming support… from international institutional investors”.
Investing in China
Tiananmen Square protests: Student demonstrations are crushed after martial law declared. Death estimates range from several hundred to several thousand.
Deng Xiaoping dies
Donald Trump embarks on ‘Trade Wars’
LIONTRUST: China - 9
Chinese debt – bearable burden or crisis-in-waiting?
In the decade to the end of 2016, China’s total debt burden doubled to more than 260% of GDP, with much of the spurt in growth coming as a form of post-financial crisis stimulus. While trade wars and tariffs have caught investors’ attention over the past year, debt levels are still creeping up and recently breached 300% of GDP.
This is very unlikely to lead to the financial crisis predicted by some any time soon. Such debt levels mean significant reform is essential, but this process is already underway as part of the rebalancing and slowdown that is key to a positive outlook for investing in China.
Connect 2 - Investing in Chinese equities
The two most prominent means of investing in Chinese companies are A shares and H shares.
A shares are company shares that are traded on China’s mainland stock exchanges in Shanghai and Shenzhen. These stockmarkets opened in 1990 and for many years were only accessible to domestic investors.
Since the opening of the Shanghai and Shenzhen markets, the Chinese have emphatically embraced equity investing. Around 200 million Chinese retail investors own the majority of A shares and account for over 80% of their trading volumes.
An alternative was a different class of shares called B shares, which were available to foreign investors. The limited number of companies and liquidity in the shares meant that these never gained traction with international investors. They are still in existence but have little liquidity.
MSCI indices: what does Chinese
A share inclusion mean?
Insights and Views on China
The mainland Chinese A Share market is by many measures one the biggest in the world. The two mainland exchanges for A Shares, Shanghai and Shenzhen, have market capitalisations of US$3.9tn and US$2.4tn respectively (source: World Federation of Exchanges, 2018). This puts the country on a par with the world’s larger exchanges. In Asia, the Japanese exchange alone is bigger (US$5.3tn); Euronext, the largest exchange in continental Europe (US$3.7tn), is smaller than Shanghai; making the US exchanges the only ones with significantly greater scale (the NYSE and NASDAQ have respective market caps of US$21tn and US$10tn).
10 - LIONTRUST: China
The US and China: From Ping Pong Diplomacy to Trade Wars
Fundamental ideological differences have defined relations between China and the US since the communist party took control in 1949.
Almost immediately, the pair were pitted against each other with China sympathising with the North Korean People’s Army when the Korean War began in 1950 while the United States intervened on behalf of South Korea. These tensions played out again during the Vietnam War. During this time China remained largely closed off from the rest of the world.
A Silk Road for the 21st century
The Silk Road was a network of trade routes spreading from Xian, in Eastern China, to the Mediterranean in the west. It was formally established during the Han Dynasty (207 BC – 220 AD), and in the 19th century was named the Silk Road by a German geographer, Ferdinand von Richthofen, to reflect one of the main products traded along it. It linked China to the Mediterranean, Africa and the Arabian Peninsula.
LIONTRUST: China - 11
The World’s Top 10 Economies:
Source: Liontrust, World Bank World Development Indicators. GDP in 2018 US$bn
Source: Liontrust, World Bank World Development Indicators. GDP in 2018 US$bn
12 - LIONTRUST: China
Mark Williams (right), Carolyn Chan (centre) and Shashank Savla (left) have more than 60 years of combined experience in analysing Asian companies. Mark, with 24 years’ experience in investing, has previously run funds at F&C and Occam. While managing the F&C Pacific Growth Fund, it was awarded first place in the Equity Asia Pacific (ex-Japan) sector over five years (out of 52 funds) by the S&P European awards in 2007. Carolyn has 25 years of experience and was previously at Hampton Investment Management. Shashank has 13 years of experience in financial markets and has also previously worked in the Consumer Goods and Telecoms industries.
Meet our experienced investment team
Liontrust Fund Partners LLP
2 Savoy Court, London WC2R 0EZ
Client Services +44(0)20 7412 1777
Administration and Dealing (UK Funds) 0330 123 3822
Administration and Dealing (Global Funds) +353 1 900 6701
Authorised and regulated by the Financial Conduct Authority
LIONTRUST: China - 13
Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and
regulated in the UK by the Financial Conduct Authority (FRN 518165) to
undertake regulated investment business.
Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
Investment in Funds managed by the Asia team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation.
This document should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing. 19/546