The best funds to invest in China

When news of the emergence of Covid-19 in Wuhan first hit our screens it looked disastrous for China, yet their authoritarian approach has enabled them to contain the problem far quicker than western democracies. The world’s second largest economy has actually grown this year and its stock market has delivered strong returns, which are accessible via a number of specialist funds. 

The pictures of Wuhan in lockdown will linger long in the memory, but despite being the source of the outbreak it turned out that the country was better equipped than most to deal with the virus. Its brutal ability to implement tight controls on the population would never work in the west, yet it seems to have allowed it to reach the other side far quicker than our liberal democracies. 

According to the International Monetary Fund, China’s economy is expected to be 1.9% larger this year compared to last. This is in sharp contrast to the US, which is expected to shrink by 4.3% in 2020 and the UK that will probably contract by around 11%. 

Rob Morgan, an investment analyst at Charles Stanley, says that growing consumer markets and an expanding financial ecosystem mean that China is potentially the most exciting investment opportunity globally. 

“President Xi has adopted a new approach to China’s development to tackle the twin problems of western resistance to the Chinese trading model and the continuing negative impact of the pandemic on western economies. He has called for a ‘dual circulation’ economy to reduce their dependence on exports, generate more domestic consumption and encourage domestic technology development.”

At the recent Communist Party plenary, it was decided to push on with the urbanisation strategy to bring more people out of villages and reduce the migrant workforce. More people will be encouraged to buy property, which will support continued urban construction, while substantial new infrastructure projects have also been given the go ahead. 

Ryan Hughes, head of active portfolios at AJ Bell, says that over the long run China has the potential to be the leading economy in the world and currently accounts for around a fifth of global GDP. 

“This is a figure that is only going to grow over time as average incomes increase and the country moves from being a low cost manufacturing exporter to a more developed consumer economy. Having exposure to this growth is the key attraction for investors and one that should persist over many years.”

Growing role in investment portfolios 

Research from Baillie Gifford suggests that China is significantly underrepresented in global portfolios. The data from last year showed that the country accounted for 18% of world market capitalisation, but only 2.5% of global funds’ allocations. 

This lack of ownership of Chinese shares by international investors is beginning to change as the country assumes a greater share of world indices. Prior to 2018 its ‘A shares’, which are incorporated in China and trade on the Shanghai and Shenzhen exchanges in local renminbi, were excluded completely, yet they now account for more than five percent of the MSCI All Country World Index, with just Japan and the US ahead of them. 

China has an even more significant role in the Emerging Markets where it makes up 42% of the MSCI EM index. The simple fact is that it is too big for institutional investors to ignore and the investment flows into the country are likely to continue to grow over the coming years. 

The domestic market is huge with over 4,000 listed companies with 700 in the A share index, of which over 70% would be large enough to qualify for the FTSE 100 if they were listed in the UK. This is a vast, untapped market of potential opportunities for long-term investors.

Darius McDermott, MD of Chelsea Financial Services, says that China is one of the few countries in the world showing signs of growth and has dealt with Covid-19 better than many of its counterparts.

“Its stock market is opening up to foreign investors, so investment opportunities are plentiful and the long-term consumption story is also very strong, with growing middle classes spending more. China is a tech heavy country, which is benefitting from leap-frogging things like fixed landlines and going straight to mobile.”

The local tech stocks have been an important driver of returns, much as they have in the US, with huge companies like Alibaba and Tencent dominating the index.  

“Many of its technology companies benefit from the size of the domestic Chinese market, making them giants in this space even though they don’t expand much outside of the country. It is very hard for foreign competitors to get a foothold in the domestic market, which allows these tech businesses to grow their customer base rapidly,” explains Adrian Lowcock, head of personal investing at Willis Owen. 

Reasons for caution 

There is no getting away from the fact that investing in China has its own set of risks. One of the most important of these is the trade war with the US, which could have major repercussions, despite the more restrained approach by the new president. It is also possible that there could be a backlash against the country as the source of Covid-19 and all the damage that it has done to the global economy. 

Tensions surrounding the role played by Huawei in building 5G networks around the world could sour relations with many different countries. Australia is a good example, where China has reacted to the barring of the company by ordering traders to stop buying some Australian commodities.

Hughes says that China remains a long way from the free market approach of western democracies and as a result, the risks of investing in the country remain high, although standards are improving rapidly. 

“Without doubt, issues such as corporate governance and ESG are some way behind where they need to be, but that is being recognised by more and more companies and positive steps are being taken.” 

The country is controlled by the Chinese Communist Party, which has no scruples in intervening whenever it is challenged. Hong Kong is a prime example, although it is also true at the corporate level. 

On the third of November the joint listing of Ant Group on the Shanghai and Hong Kong stock exchanges was suspended after Jack Ma was summoned by Chinese regulators for supervisory interviews following criticism of the state-owned banks. Ma is the co-founder of Alibaba, China’s largest online commerce company, which owns a third of Ant Group. Its New York-traded shares fell heavily after regulators halted the record-breaking $37bn IPO. 

“The abrupt halting of the Ant Financial IPO is a stark reminder that it is the Chinese authorities that give companies the license to operate and they can change the rules and regulations any time they want. China is extremely supportive of local companies, but in return Beijing expects a degree of control that you wouldn’t normally see in other countries,” warns Morgan.

Another point to bear in mind is that if there was a reversal of fortune for large tech then it could be a major issue as Alibaba and Tencent alone make up around 35% of the MSCI China index. China also has an ageing population because of the one child policy in the 1980s, so it risks getting old before it gets rich.

Investing in China

In the past UK investors have mostly used regional Emerging Market or Asian equity funds to gain exposure to China, but the growing influence of the country’s economy and stock market would suggest that a dedicated allocation might be a good idea. 

The country’s move to being more domestically driven has enabled it to shield from some of the economic impact of the global slowdown, while the fact that it is home to resilient businesses in the technology and healthcare sectors has helped to deliver strong returns. At time of writing the Shenzhen Component index was up 28% year-to-date. 

There are 39 open-ended funds listed in the Investment Association’s China/Greater China sector and year-to-date it has been the second strongest performing area of the market after technology with an average return of 30%. Over the last five years it is up by 120%. 

If you prefer investment trusts there is a much more limited choice with the analysts at Winterflood listing just three options. The largest of these with assets of £2.4bn is Fidelity China Special Situations (LON:FCSS) covered in the fund of the month section below. 

Alternatively there is the new £200m Baillie Gifford China Growth Trust (LON:BGCG) that was formerly known as Witan Pacific. The mandate has now passed to Baillie Gifford whose growth-oriented funds dominate the performance tables in recent years. 

BGCG’s portfolio will be similar to the firm’s open-ended China fund, but will take advantage of the closed-ended structure by using gearing to increase the potential returns and by investing in less liquid areas like the small caps and unquoted stocks. Unfortunately it is currently trading on a 24% premium to NAV, so it might be best to wait for a better entry point. 

The best open-ended funds 

Hughes believes that over the long-term the domestic A share market will be a highly attractive place to invest and because of this he recommends the Allianz China A Share fund as an interesting satellite holding in a well-diversified portfolio.

“The team at Allianz have been investing in domestic Chinese equities for over a decade and manage $7bn in the strategy. They focus on the best quality growth companies and as a result, the portfolio is concentrated with between 50-70 positions.” 

Morgan prefers the First Sentier (formerly First State) Greater China Growth fund that invests in high-quality businesses in China, Hong Kong and Taiwan.

“Asian equity veteran Martin Lau has been the fund’s lead manager since its 2003 launch and has been successful in keeping up with the dynamic and evolving markets. He prioritises well-run businesses that can deliver consistent growth in earnings over time and can draw upon a large Asian equity team based out of Hong Kong and Singapore.”

McDermott likes the Invesco China Equity fund, which was previously called Invesco Hong Kong & China. Exposure was historically through investment in shares traded on the Hong Kong stock exchanges, but it has now increased its investment in the China A shares listed in Shanghai and Shenzhen.

“Managers Mike Shiao and Lorraine Kuo along with their experienced, on-the-ground team of analysts, have an excellent stock-picking track record. With the fund’s mandate and benchmark evolving as the A-Share market gains prominence, it is very well positioned to continue to offer market leading performance.”

Lowcock prefers the Fidelity Funds China Focus Fund where manager Jing Ning has a value tilt with a focus on companies that have been disregarded by the market due to either economic or company specific reasons. He says that Ning has been able to add value by investing in those businesses that have been able to turn things around.

FUND OF THE MONTH 

The £2.4bn Fidelity China Special Situations (LON: FCSS) investment trust is a higher risk option with significant concentration at the stock level, as well as some unlisted companies and gearing that is currently around 25%, which magnifies the gains and losses on the underlying portfolio.

Hughes says that manager Dale Nicholls has extensive experience of working in the region and is backed by a big team of analysts who support the investment process. 

“The trust is underweight the two big stocks in the index – Alibaba and Tencent − but still has 24% in these two companies so the performance could well be volatile, but the long-term results are strong, thereby making it a useful addition to a well-diversified portfolio.” 

Morgan is also a fan and says that the recent strong performance has been powered by large holdings in the tech stocks, as well as several consumer stocks aligned with the growth of China’s middle classes. 

“Nicholls makes full use of the investment trust flexibility and will gear when deemed appropriate, but will also take short positions (to profit from price falls) in single companies and indices. Investment in unlisted companies is capped at a maximum of 10% of NAV with Bytedance, owner of TikTok, being a recognisable example.” 

Over the last ten years the trust has generated a share price return of 269%, which is well ahead of the 151% produced by its MSCI China benchmark. Recent optimism has closed the customary discount and the shares are now trading close to NAV.