Why Evergrande is not China’s ‘Lehman moment’

What we are seeing with Evergrande is in part the direct outcome of a proactive policy tightening and more stringent regulation of the property development sector that has taken shape in China over the course of the past year and longer.

One significant difference is Lehman’s was an investment bank with huge counterparty liabilities across the financial sector given interlinkage of derivative transactions. Evergrande is a company that builds a product (homes) and sells them but has overstretched itself – this implies the systemic risks are lower than that of Lehman’s.

While it is possible that the Chinese government will let Evergrande go bankrupt, we do not expect a wider contagion from a potential collapse. The vast majority of instances where individual events create wider spread contagion tend to be in circumstances where excess leverage has been allowed to build up broadly within certain parts of the economy, normally in the blind spot of policy makers and capital market participants. We should also remember that we have experienced a period of significant policy tightening in the property sector, which provides significant policy room to loosen from here.
 

Regulatory crackdown

 
The latest crisis comes after Chinese equities have fallen sharply in recent times following tougher-than-expected regulations targeting the education sector announced at the end of July. The crackdown on the education sector comes after a year in which China’s regulators have taken a tough stance on a number of issues including data privacy, cyber security and antimonopoly concerns.

From a timing and historical perspective, it is certainly not the first time we have witnessed heightened regulation in China. While not without some risk, history teaches us that these times can be the most opportune to invest – attractive valuations coupled with conviction in a company’s business model, management team and its long-term growth opportunities.

We are seeing many companies in the tech space now trading at historical low valuations and at significant discounts to global peers. We acknowledge that there is potential for business models to change and are adjusting down our expectations around monetisation levels in certain companies. Having said this, investment is all about risk-reward and, for many names, this is looking favourable after recent moves.
 

Focus on the long-term

 
Whilst we can’t predict the details of every single policy move, it is important to keep in mind the historical context and the longer-term goals that have been laid out.

China has clear priorities around economic growth including doubling its GDP per capita again by 2035. It’s hard to argue that a vibrant and healthy private sector isn’t essential to achieving this aim. Priorities around innovation are also clearly rising – many of the companies in the sectors we are talking about are not only big employers and drivers of growth, but also drivers of innovation.

China has also made no secret about its goals around developing its capital markets and internationalising the RMB. Clearly, the creation and evolution of a stable investment environment – for both domestic and foreign investors – has to play a part.
 

Balancing risk and reward

 
Overall, it’s important to reiterate that government regulation is a constant in China – any investor must accept and incorporate this into one’s risk-reward framework.
Many new policy initiatives are still evolving and can cause uncertainties. This is why it is key for me and Fidelity’s analysts to continue to incorporate this into our assessment of the long-term prospects for a company’s business model and its management team.

Investing at the end of the day comes down to risk reward and, with the correction we have seen, this is tipping in our favour. Yes, sentiment is poor, but it usually is at the most opportune times.