Global funds are cautiously venturing back into Chinese equities after prices collapsed to 4-1/2-year lows in February, taking advantage of cheaper valuations to buy stocks they believe will benefit from China’s shift to a consumption-led economy.
Foreign investors are tentatively buying in sectors linked to the main themes of the 13th Five-Year Plan released earlier this month, including urbanization, consumption, internet growth, green development and innovation.
The MSCI China index has gained 17% since Feb. 12 and while foreign investors are still net sellers the scale of net selling has shrunk to $272 million from March 1 to March 25 versus an average of $2.1 billion over the previous four months, according to EPFR Global data.
Most investors are focusing on specific “new economy” industries, which make up only a small proportion of the market, while avoiding those sectors linked to the “old economy.”
“China’s transition to a consumption and service-led economy is likely to be a bit painful, and it’s worse for the stock market because 70-80 percent of the market is highly dependent on the infrastructure and investment-led economy,” said Tan Eng Teck, senior portfolio manager at Nikko Asset Management in Singapore.
“But the remaining 20-30% is growing, and we like those sectors because they’re in a multi-year growth phase.”
Beijing’s five-year plan aims to create at least 10 million urban jobs, boost research and development investment to 2.5% of gross domestic product by 2020, develop alternative energy sources and reduce emissions, and expand internet penetration.
Tan’s prefered sectors include tourism, insurance, environment and healthcare. Among the biggest holdings in Nikko’s China equity fund and Shenton Greater China Fund are Ping An Insurance, internet firm Tencent and China Traditional Chinese Medicine Co..
M&G Investments combines the internet and consumption growth themes, with recent purchases including an online travel agency listed in the U.S., said Matthew Vaight, M&G portfolio manager for global emerging markets in London.
Internet firm Baidu and mobile operator China Unicom are among the top 10 holdings of M&G’s Global Emerging Markets fund.
However, Vaight cautions that some “new economy” stocks are overvalued, and sees opportunities for value investors in “relatively dull but under-appreciated areas of the market,” such as some packaging and plastic pipe companies.
Banks and commodity sectors are seen as value traps. Vaight warns that banks are keeping many struggling “old economy” companies going when they should not.
Tan cautions overcapacity in commodities sectors such as steel and aluminum means that prices, despite very low valuations, could yet fall further.
Barings Asset Management also favors “beneficiaries of rising consumption and technological outfitting as Chinese companies move up the value chain,” investment director William Fong said in a note last month.
For instance, Barings is investing in China’s population expansion and improving environmental standards through a utility company that supplies water to Hong Kong, Shenzen and Dongguan, he said.
Barings also likes Chinese entertainment companies, betting on increases in both the number of cinemagoers and locally produced films.
“With share price valuations having moved quite sharply in recent weeks, we have taken the opportunity to reassess companies we previously liked but where we felt the price was too high,” said Fong.