China – Feature
growth model that China adopted in the early 1990s – exam- ples he cites are Japan in the 1970s and 1980s and Brazil in the 1960s and 1970s – have gone through three distinct stages. The first, characterised by heavy investment in much-needed infrastructure, delivered many years of rapid growth. In this stage, debt grew in line with the economy because when debt mostly funds productive investment, gross domestic product grows faster than lending.
In the second stage, each country sought to rebalance demand away from investment, typically with little success. Growth remained fairly high, although it is now driven increasingly by non-productive investment. When this happened, total debt in the economy grew faster than GDP, resulting in a growth of the debt burden. Finally in the third stage, the country either reached its debt capacity ceiling or a worried government took steps to prevent lending from rising further. Either way, the economy was forced to rebalance away from investment and towards con- sumption amid far slower, sometimes even negative, growth. On this analysis, China is still in the heady days of stage two. But stage three is up next and reality could well bite.
Emerging cracks
There are parts of the economy that could already be seeing cracks as a result. “China’s economic growth is uncertain,” one wealth manager warns. “Much of the recent slowdown has been fuelled by the wider impact of the collapse of huge prop- erty developers such as Evergrande.
“There are now serious worries that this could initiate a worry-
ing credit crunch that would be disastrous for the world’s sec- ond-largest economy, which would have global repercussions.” On such an outlook, should there be a limit to how much investors should allocate into the country? “Any investment, whether it be an allocation to Chinese equities or UK corporate bonds, should be considered holistically – and against a set of long-term objectives and constraints. For example, risk toler- ance,” Pascal says. Instead, Pascal presents a different China narrative. “More broadly, we have seen other market participants claim that investors are under allocated to China when you take into account the size of the investment opportunity, the potential for growth and the diversification benefits an allocation to China can bring to a portfolio.”
On the point of investors keep an eye on the developments within the political sphere, Allen notes: “On portfolio invest- ments, one needs to be careful to listen to the words of the Chi- nese leadership, to watch where they want to go and invest with the flow.
“China is not anti-entrepreneur or anti-business at all,” he adds. “But it is insistent that Chinese priorities be met, that Chinese social issues are addressed and that Chinese law is fol- lowed. If you are not comfortable with that, it is probably best to invest elsewhere.”
China is still capable of real innovation and at a comparative advantage. One portfolio manager says it is likely China will strive to build its own biotech industry, which can deliver at a price point that beats all competition. “Over time, as we have seen in areas like semi-conductors, AI and robotics, there is a strong chance that China can catch up in totality, versus US and European capabilities,” he says.
Investors are well justified in asking whether China has entered a new socio-economic paradigm and whether social- ism with Chinese characteris- tics isn’t just a cover for plain old-fashioned socialism. Richard Bullock, Newton Investment Management
This presents a picture of the continuous rise of China, with China’s investment-led approach delivering high returns for the foreseeable future.
And it is on the strong macro-economic factors that contribute to the convincing arguments for institutional investors to gain exposure to the country. “China is evolving as an economy, shifting away from manufacturing and exports and towards services and consumption,” Pascal says. “The population is becoming more urban, is ageing, is becoming wealthier and more environmentally conscious. All of this will create oppor- tunity for investors.”
A key lesson for other investors and asset owners to follow is not just dipping in and out of the country but getting in at the ground level. “In our view, having boots on the ground and an understanding of cultural and regional differences is key to extracting long-term value,” Pascal says. “We see lots of oppor- tunity in China, and not just in those sectors that you would consider high growth.”
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