A-shares’ growth requires an ‘all-China’ approach
With the Stock Connect scheme, which first started in 2014 and expanded in 2016, global investors can now access more than 1,560 out of over 3,000 stocks listed onshore in China. This compares with 225 H-shares and under 300 ADRs traded in US stock exchanges and over-the-counter (OTC) markets.
According to Jack Lee, Schroders’ Shanghai-based Head of China A-shares Research, the A-share market is home to some of China’s most innovative and fastest-growing companies that are more aligned with China’s economic expansion. These economic developments include the trend towards consumption of higher-grade products, increased healthcare spending and the rise in the number of high-tech related software and hardware companies.
"There are some industry leaders that are related to the economy that are not listed in the offshore space and these include prominent home appliance makers and retailers and major China’s liquor, tourism and media companies,” adds Lee.
Head of China
A-shares Research
The recent addition of the Shenzhen market to the Stock Connect scheme in particular makes available many new, small and mid-cap “growth stocks” in fast-growing sectors such as IT, science, healthcare and technology, says Lee.
About 75 percent of the companies in Shenzhen are non-SOEs (state-owned enterprises), presenting interesting and emerging investment opportunities for global investors, based on Schroders’ analysis. Schroders’ 19 strong Greater China investment team consists of four fund managers in Hong Kong, and 15 research analysts based in Hong Kong, Singapore, Taipei and Shanghai.
MSCI inclusion signals maturing of A-share market
This diverse offering comes against a backdrop of continuing maturity and development of the Chinese stock market as well as efforts by the government to ease capital controls. Among the breakthrough events that signalled China’s growing significance in the stock market is the prospective inclusion of approximately 222 stocks in the MSCI Emerging Market Index in May and August next year. “MSCI’s five percent inclusion factor for currently qualified A-share listed stocks is just the beginning,” says Lee. “China’s stock market is growing very rapidly; this year there are some 300 to 400 IPOs (Initial Public Offerings); institutional investors can no longer ignore this market.”
Global norms may not apply
Given such a large market, there is no lack of choices but the flip side is how to identify the winners from the laggards, says Lee.
“In a fast-growing economy, the boom and bust cycle can be relatively short,” explains Lee. “A company that is regarded to have a stable business model with steady cash flows and yields could be disrupted within a short period and we have seen many cases like these over the last decade.”
Lee also advised investors to keep an open mind about valuation. China’s fund-raising environment, government rules and approval processes are sometimes friendlier than more established markets. “You can’t compare horizontally across the same industry because the external environment is different. The cost of capital is different in every market,” says Lee. “A company that is trading at a premium in China could well be deserving of that premium,” he adds.
Governance a key focus of Schroders' ESG consideration
To identify good quality companies, Lee says Schroders takes an active fundamental approach is to seek out entities with high quality management and those that meet the investment manager’s ESG (Environmental, Social and Governance) criteria.
“While we are seeing the E (Environmental) being considered increasingly by companies in China; S (Social Responsibilities) to a lesser extent; the focus here is really on G (Governance),” says Lee, adding that an encouraging sign is that Chinese companies have consistently made improvements in corporate governance in recent years.
Another factor that should be taken into consideration while identifying quality companies is that management’s interests should be aligned with both the majority and minority shareholders.
Two key investment themes
Lee has identified two key investment themes: China’s consumption upgrade trends and its high-value tech industry.
“Chinese consumers are becoming increasingly sophisticated, and many are willing to pay a premium for better quality products and services,” say Lee.
Another growing industry is China’s technology sector.
A-shares' technology offering
A comparison of the sectors listed in the offshore markets, including ADRs, H-shares, Red-Chips (China-based companies incorporated internationally and listed on the Hong Kong Stock Exchange) and P-Chips (Chinese companies listed on the Hong Kong Stock Exchange which are incorporated in the Cayman Islands, Bermuda and the British Virgin Islands), showed that A-shares offer the widest variety and highest number of IT companies.
Head of Institutional Business, Asia Pacific
Consider an "all-China" approach
Going forward, mainland stocks will inevitably play an increasingly integral role in asset allocation for global investors as China A-shares gain prominence with the gradual structural changes introduced by the government.
“As investors weigh up their investments in China and contemplate investing directly onshore in A-shares, it is important to note that China’s two domestic stock exchanges in Shanghai and Shenzhen offer the largest equity markets in Asia, and are second only to the US markets in terms of size and trading volumes globally,” says Chris Durack, CEO of Hong Kong and Head of Institutional Business, Asia Pacific.
“In ensuring that investors continue to be presented with the most relevant investment opportunity set in China, we believe an “All China” equity approach should be considered. A relevant approach is to consider a benchmark mix of the MSCI China and MSCI China A,” Durack adds. “In this regard, Schroders’ deep experience makes us ideally placed to help our clients with tailored solutions,” he says.
Schroder Investment Management (Hong Kong) Limited
For more information, please visit the Access China section on www.schroders.com.hk/access-china