China will benefit from slower economic growth as the government's reform plans have put it firmly on the right growth path.
This is the view of Gary Greenberg, Citywire AA-rated manager and head of emerging markets at Hermes Investment Management.
Greenberg currently has a 10.6 percentage point overweight to China in his Hermes Global Emerging Markets fund. It currently makes up 30% of the fund geographic exposure at present.
In his latest commentary, Greenberg said he is not concerned about China’s slowing growth, which may not meet its 7.5% target for 2014, as reforms are likely to put the Chinese market on a better long-term footing.
‘Over the previous decade, the earnings growth of Chinese companies had been diluted, with capital having been channelled towards breakneck expansion rather than generating shareholder value.’
He added that lower capex spend for companies will mean a reduction in the pressure to issue new shares, allowing EPS growth to come back into line with earnings growth. ‘Capital itself can be turned to more profitable ends or returned to shareholders.’
Greenberg, who said last January that China looked ridiculously cheap, is currently exposed to the Chinese consumer stocks, internet-related companies and the business services sector, as he said these areas continue to grow robustly.
On the other hand, he has a minimal exposure to property and banks, but thinks that authorities have room to tackle the real estate issue.
‘There are policy options available for dealing with the property bubble, such as shanty town relocation to areas with high vacancy rates,' he said.
'In addition, reforms providing the huge unregistered workforce with work permits would both create housing demand and increase labour force participation in more skilled industries.'
The credit boom
Another serious concern surrounding China, according to Greenberg, is the wave of debt issued recently, with a 16% increase of credit creation year-on-year, more than doubling GDP growth.
‘Since the crisis, China’s economic rescue efforts have produced three credit-fuelled investment booms: in infrastructure, real estate and mining and manufacturing. Growth was sustained through pump-priming the predominantly state-owned enterprises in these areas, creating excessive leverage.’
Greenberg said the government now has to perform the delicate manoeuvre of streamlining the state-owned enterprises, while deflating the credit bubble in a controlled fashion.
‘This will allow efficient companies to effectively compete, but at a pace that does not cause indebted state-owned enterprises to collapse before private industry can take up the slack. This may explain the recent mini-stimulus and seemingly slow pace of reform over 2014,’ he added.
Over the past three years, the Hermes Global Emerging Markets fund returned 23.74%, 9 percentage points more than the MSCI EM benchmark.