China is proving a ‘paradox’ for emerging market investors as liquid and disperse markets should produce more investment but are actually driving money elsewhere, according to David Raper.
Citywire AAA-rated Raper, who runs the Comgest Growth Greater China fund, told Citywire Selector that the Shenzhen-Hong Kong Stock Connect launch boosted visibility but has not spurred foreign investment.
Raper said the initiative, which came into effect in December 2016 as part of internationalisation efforts, has not moved the needle when it comes to raising foreign ownership in the country.
‘The opening of the mainland equity market has largely been ignored by foreign equity investors over the past three years as the divergence between investable quotas and actual holdings in the chart below suggests.
‘It’s a paradox: high share return dispersion in China plus very liquid equity markets and high active share are the best ingredients for alpha generation. Yet, the higher the active share among emerging market equity managers, the less they are inclined to invest in China.’
Raper said country allocations are being impacted by negative macro views, with most emerging market fund managers seemingly not built up adequate micro skills to stock pick at a local level.
‘Without local stock-picking skills, high share return dispersion is seen as a risk rather than an opportunity for alpha generation. Possibly the truth lies somewhere in between,’ Raper added.
Raper said the headline make-up of the Chinese index could be providing an impediment to some investors, as they only see state-owned enterprises due to their heavy weighting in the index. He said this is where local stock-picking has to be prioritised.
‘With the ongoing transformation of the Chinese economy towards more consumption and services, and considering the diversity and breadth of its stock market, the opportunities for stock-picking in China are not likely to wane. But to fish in such a big pool, careful consideration needs to be made when selecting investment choices.’
Raper named Baidu, the Chinese equivalent of Google, as one stock that is dominating in new areas, while high-end alcohol company Kweichow Moutai is also showing growth thanks to ‘new China’.
‘The company successfully transitioned from being the official banquet liquor of the Chinese military to a strong brand preferred by the Chinese middle class. Branding and distribution skills have been the key to this successful transformation. Notably, management is very invested in aligning the company’s interests with ours.’
Mainland China accounts for 71% of exposure in the Greater China fund at present, compared with a 54.6% index allocation. Hong Kong only accounts for 3.9% against an index weight of 20.5%.
The Comgest Growth Greater China fund returned 47% in US dollar terms over the three years to the end of March 2017. Its Citywire-assigned benchmark, the MSCI Golden Dragon TR USD, rose 23.75% over the same timeframe.