The specter of Chinese regulators continues to haunt foreign investors, with owners of Macao gaming stocks in the crosshairs last week. But analysts in Asia say the pain resulting now from regulatory tightening should set the stage for gains down the road.
„It may not sound convincing to a lot of people right now“ but if the flurry of steps China’s regulators have taken this year allow greater scope for innovative small- and medium-sized companies to thrive, this could actually be good for the Chinese economy, said Nicholas Yeo, Hong Kong-based portfolio manager of Aberdeen Standard Investments‘ $4 billion China A Share Equity Fund.
When the dust eventually settles on the current round of reforms — which could prove unusually long and far-reaching — investors may find that China has taken a lead globally in areas of concern, from data privacy issues to curbing the monopolistic influence of big internet platforms, Mr. Yeo said.
The reforms moving forward now under the government’s banner of „common prosperity“ are aimed at achieving „more balanced, consumption-driven, innovation-driven growth,“ agreed Chris Liu, Hong Kong-based senior portfolio manager, China A investments, with Invesco Hong Kong Ltd.
Consumption growth in China has been sluggish in recent years, in part because of considerable income inequality, impeding the government’s goal of moving to a consumption-led growth model from an investment-led engine, Mr. Liu said.
„Consumption growth is very crucial“ to setting the stage for the next phase of China’s economic development, he said.
UBS AG’s chief investment office, global wealth management investment research reached similar conclusions in a recent report on China’s „common prosperity“ campaign: The country’s ongoing regulatory clampdown might keep volatility elevated in the short term, but „we believe the end result will be a healthier, more sustainable economic balance that allows innovation to thrive and wealth to accumulate more evenly.“
On Sept. 15, however, when Macao’s government announced a coming review of the special administrative region’s casino sector, volatility and pain were back in fashion. The value of Macao’s Hong Kong-listed gaming stocks — widely held by overseas money managers, including Capital Group Cos., J.P. Morgan Asset Management and Franklin Templeton Investments — plunged $18.4 billion in a single session.
While a tightening regulatory grip on internet platform giants such as Hangzhou-based Alibaba Group Holding Ltd. and Shenzhen-based Tencent Holdings Ltd. have caused bigger drops in market value this year, analysts pointed to Beijing’s July 23 regulatory strike — effectively dismantling an after-school-tutoring industry that had attracted billions of dollars of foreign investment by insisting that education companies become non-profit institutions — as a bigger factor behind that hair-trigger response by gaming stock investors.
Aberdeen’s Mr. Yeo said his A-shares portfolio fell 12% in July, with the shock announcement about the education sector sparking a fairly indiscriminate sell-off by foreign investors. „They basically extrapolated the same fear across other sectors and decided to sell first and worry later,“ he said.
Mr. Yeo declined to mention specific portfolio holdings, but a list of his fund’s top 10 positions saw companies as disparate as alcohol maker Kweichow Moutai Co. Ltd., home appliance manufacturer Midea Group Co., China Tourism Group Duty Free Corp. Ltd. and Foshan Haitian Flavouring & Food Co. Ltd. all dropping between 37% and 43% from highs posted in February.
Aberdeen’s investment team took advantage of that sentiment-driven environment to selectively top up on some of the companies that had been indiscriminately sold off, he said.
Portfolio managers said one lesson of the past year is the necessity of focusing more than before on Beijing’s policy priorities and how they can impact the universe of Chinese stocks. But Mr. Yeo said that amounts to just one box to check when doing due diligence because everyone in the market will have the same information, raising the danger of crowded trades.
Meanwhile, even if China’s government is taking a more active role now in shaping the country’s economy than most of its Western counterparts, having a healthy appreciation of where the country is heading remains crucial to picking the right stocks there, analysts say.
Observers can put a negative spin on what’s happening — „the government wants more control“ — and there’s some truth to that as well, Mr. Yeo said. But „it’s not egalitarianism or socialism“ — it’s about more sustainable, long-term growth, he said.
„While regulations will impact many companies‘ future earnings potential and deflate their valuation premium, we expect (that) the profitability profile of privately owned enterprise/new economy equities won’t be structurally impaired and believe a great deal of regulatory uncertainty is already priced in,“ said Kinger Lau, Hong Kong-based chief China equity strategist with Goldman Sachs (Asia) LLC, in a Sept. 15 report.
With many of China’s big internet platform companies listed in New York, analysts warn that the trillion-dollar segment of the country’s stock universe will remain relatively vulnerable to Beijing’s „social responsibility“ push, which includes requiring better working conditions for those companies‘ army of gig workers.
For now, it may be preferable to get exposure to Chinese companies through the mainland-listed A-shares market, „which appears more insulated than offshore China equities to regulatory risks and more favorably exposed to macro policy easing,“ Mr. Lau wrote.
How long the regulatory tightening campaign will go on is an open question. The current cycle could be longer than the previous 18- to 20-month round „because the objective is to achieve common prosperity by 2035 … so this is a long-haul restructuring,“ Mr. Yeo said.
If reforms are done properly — giving smaller, innovative companies room to run without discouraging established heavyweights from innovating as well — the conditions for healthy long-term domestic consumption growth could be set, he said.
Still, while predicting a positive long-term outcome, Mr. Yeo said portfolio managers will need to „recalibrate our expectations“ in that emerging environment. „We will not be seeing that kind of super 40%, 50% growth“ of recent years. It will be more tempered in a more competitive environment, he predicted.
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