China – the (very) long game

It’s not much fun for investors in China at the moment – but this too will pass…by Pascal Dowling

 
I remember crossing The Mall close to Admiralty Arch some years ago when David Cameron was still the prime minister and Nigel Farage was still just that funny little chap with excitable views on the EU who looked like he smelled of fag ash and sour hops.

I stopped in the middle, quite frankly amazed by the sight of scores of huge scarlet CCP flags hanging from the white posts that line the ceremonial route to Buckingham Palace, marking the state visit of our new best friend Xi Jinping at what was, then, the start of what the Government hoped would be a new special relationship with China.

It struck me as an incredible sight; those flags so similar to the old Soviet banner at the very heart of the British capital which had stood against communism for most of my life at that time, like a scene from a dystopian novel – where angry beardy men stare out of posters, and everybody is called Winston and shuffles about in drab overalls, trying not to fall in love and get sent to the gulag.

Times have changed, somewhat, since those heady days when globalism was all the rage and China’s position in the world, at least in terms of its relationship with the UK and our allies, has changed with it.

Geopolitics are fickle, though, and for investors there is little to be learned from tabloid talk of an ‘axis of upheaval’, and less still from the threat posed by China having closer links with North Korea or Russia, both of which are tugboats to its supertanker in terms of their bearing on the global economic stage.

For investors in China, in my view, the key questions concern what is going on inside the country, and what is in the best interests of the people who run it via the Chinese Communist Party. These will determine the outlook for Chinese equities over the longer term; which is where any returns from an investment in China are going to come from.

With regard to the first question, China faces some really quite major challenges. The country’s travails with property and its financial sector are well known but the news, earlier this month, that China would raise the statutory retirement age for men to 63 underlines one of the most significant of all.

China’s ageing population and the consequences of its disastrous one-child policy (since abandoned) are nothing new, but the effects will take decades to play through and, as we have seen in this country, people do not take it well when the things they expect the government to provide are taken away.

China must inevitably increase its retirement age again, and again, and probably again if it is to have any hope of avoiding the disaster that it is heading for at the moment. The state-run Chinese Academy of Social Sciences said in 2019 that the country’s main state pension fund will run out of money by 2035 – and that was an estimate before the Covid-19 pandemic, which hit China’s economy hard.

Given the outrage about winter fuel payments being taken away from them I have seen among people who I know are members of a London club which charges about two grand a year for the privilege of keeping the riffraff out of the dining room, the prospect of persuading 982 million working Chinese people that they must work fifteen years longer than they’d expected down at the fireworks factory is a daunting one.

But this pain could have, and does have in my view, positive long term implications.

China is jostling for its place at the very top of the global table at the moment and Russia and North Korea are useful chips in the Great Game. That is foreign policy, brutal and tragic as its consequences may be. Back home what China needs more than an alliance with a bankrupt and starving country run by a man who looks like a block of cheap ham, and a marriage of convenience with its broke, volatile – and of late pariah – neighbour to the north, is money. Lots of it.

Self-interest – ultimately – drives most decisions. Rich countries are happy countries (despite all those surveys moaning about how unhappy the West is, they aren’t trying to stop the boats in Mauritania), and better relations with the rest of the world in the long run are then, surely, a key objective for the CCP if the people who benefit from their position within it wish to remain in power.

China remains the world’s largest exporter, but an improved position at the global table can only work in its favour when it comes to tariffs, foreign direct investment, a decreased geopolitical risk premium and better integration into financial markets.

In the meantime the party’s commitment to improving the country’s financial viability was reiterated this week, with the announcement of a $114bn stimulus package – bigger than anything seen since the Coronavirus. Thomas Gatley, of Gavekal Dragonomics thinks there may be more where that came from, and the FT argues (albeit without much vigour!) that – if these interventions are transformative – the investment case for China could improve.

China’s struggles will likely continue for some time. Its deeply wounded property market, in particular, is an intractable problem because real estate is the primary household asset in China – where the average householder has more than two thirds store of their wealth. Eventually though, a return to the fold is in everybody’s interests (even if the fold looks somewhat different in terms of its power dynamic).

How long it will be before we see the red banner flying outside Buckingham Palace again is anybody’s guess, but for those who are tempted to put a toe into the water perhaps with a 15-20 year timeline in mind for a JISA or similar, there are three trusts offering straight exposure to the sector; Baillie Gifford China Growth (BGCG), Fidelity China Special Situations (FCSS) and JPMorgan China Growth & Income (JCGI).
 
Kepler’s Ryan Lightfoot-Aminoff met the team at FCSS recently and this is his view:
 
“FCSS is a good example of a manager maximising the capabilities of the investment trust structure. By investing in a well-diversified portfolio with a bias to small and mid-sized businesses, unlisted companies and by running structural gearing, manager Dale Nicholls offers investors something totally different to what they could get from an index tracker, and can capitalise on the plethora of opportunities that the Chinese growth story still offers due to his strong active management approach. As such, we believe FCSS could make for an attractive holding as part of a core global equity portfolio that can deliver very strong alpha over the long term, albeit with some periods of volatility.”
 
Josef Licsauer, another member of the Kepler team, met JCGI earlier this month – this is his verdict:
 
“Despite these challenges, the managers remain optimistic about the portfolio’s growth potential, citing stabilising consumption trends and improved adaptability among companies, coupled with 20-year low valuations, which is broadening their opportunity pool.

“For investors with an iron stomach and a long investment horizon, we think the value within the Chinese market looks potentially attractive. Chinese equities have the potential to rally quickly if economic tensions ease and sentiment improves, and given JCGI’s greater growth profile than the market, it could subsequently lead to an uptick in performance and a narrowing of the Discount.”
 

 

Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.