Chinese A shares: Opportunities in a changing economy

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Baijing Yu, fund manager and  David Raper, managing director for the Comgest Growth Greater China Fund range argue that changes in the Chinese economy offer attractive opportunities for investors in the A shares market. 

  • Hong Kong Shanghai Connect and the announced Hong Kong Shenzhen Connect is increasing liquidity of A shares and providing new opportunities for fundamental-driven investors
  • This has coincided with major reform agendas – good news for stock pickers
  • Pockets of the market look over heated but there is still compelling value to be found
  • We have started research into A shares since 2011 and increased our exposure to China A-shares to approximately 20%, ahead of our peers

The Hong Kong Shanghai Connect has had an enormous impact on the equity market in China, increasing liquidity of A-shares. This liquidity is set to increase with the highly anticipated Shenzhen Hong Kong connect likely to be launched later this year. We believe there are interesting opportunities in A-shares that have previously been unavailable overseas for long term oriented investors because of the limited and cumbersome QFII and RQFII systems.

This financial market opening has coincided with a collection of major reform policies such as Hukou (Social identity registration system) reform and state-owned enterprise reforms. The fact that the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) has shifted the primary metric of measuring state-owned-enterprises’ performance from revenue growth to asset turns is perhaps the single most important indicator of the commitment to change, bringing together shareholder interests with that of the government.

One highlight for stockpickers is Kweichow Moutai, the most recognized Chinese white spirit brand with over 60 years heritage. The company has been on our selective A share universe since our QFII status in 2012 and has been an early A share holding across Comgest portfolios. Moutai is one of very few domestically grown luxury brands that resonate with Chinese consumers. Its unrivalled brand status is enabling the company to smoothly sail through the current industry volatility, affected by Beijing’s pro-longed anti-extravagant spending campaign and sector overcapacity issue. We continue to believe Moutai’s brand position and healthy balance sheet to generate sustainable growth in the long term. While it is no longer as much of a bargain as it once was, the current 16x NTM PE still represents a very reasonable valuation for the solid franchise.

We clearly see that the trend for better corporate governance, mixed private/foreign ownership, management and employee share participation is an ongoing trend in the country, which should put the focus of corporates in China more in line with shareholder interests than in the past. As a result, the quality of earnings should improve with time, even if macroeconomic growth is likely to slow down. For quality growth investors like Comgest, this is clearly good news. We invest in companies, which follow an autonomous growth path based on micro economic strength and not macro- economic tailwind.

So far the market rally in China has been strongly driven by retail investors. Due to this, some segments of the market look over heated. For example, ChiNext, an index for fast growing and tech stocks, trades at a 2015 PE of more than 70x. Ironically, for the inverse reason, the less loved names by the retail investors, namely the more stable growth and “boring” companies, offer compelling valuation levels for the long term.

Finally, the cost of investing in China A-shares has fallen dramatically over recent quarters. This has further encouraged liquidity and competition amongst brokers has increased. We have increased our exposure to China A-shares over past years, which now make up approximately 20% of our Comgest Growth Greater China fund, significantly ahead of our peers.

 

 

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