Chinese equity valuations have reached compelling levels following a recent correction, with macroeconomic tightening and fear of inflation largely priced in, believes Baring Asset Management.

At a conference in Hong Kong yesterday, the firm’s Hong Kong/China equities investment manager William Fong said he expected upward momentum in the equity market, supported above all by infrastructure development and increased domestic consumption.

The forward price-to-earnings multiple of MSCI China stands at around 10 times, below the historical mean of 12.7 times, Fong noted.

Only last week, Chinese premier Wen Jiabao reiterated his belief that the country was on track to curb inflation. Subsequently the Shanghai A-share index rallied 3.6% over two days on June 23 and 24, an indication of pent-up demand to build long positions after a period of correction, suggested Fong.

China had been proactive in its tightening measures and domestic inflation was likely to peak by the third quarter, he added. Consequently, Fong expects a relaxation in macroeconomic policy towards the end of this year.

Nevertheless, policy risk remains. “The key stock positions in the portfolios we manage are those which we believe are likely to be less affected by rising inflationary pressures and policy measures,” said Fong.

Asset managers are expected to remain cautious about investing in sectors sensitive to interest-rate rises such as banking and property, where performance has been constrained over the past year amid concerns about the potential impact of further monetary tightening.

Referring to China’s 12th five-year plan for 2011 to 2015, Fong said that China’s economy would benefit from rising consumer spending, augmented by a growing middle class and continued wealth creation, as authorities encourage sustainable growth. 

As at May 31 this year, consumer discretionary accounted for 21.9% of the Baring China Select Fund, compared to just 5.3% for the MSCI China index. Amid improved national living standards, healthcare counted for 3.7%, against 0.8% for the benchmark index. 

Fong also noted that significant spending in the infrastructure sector is typically realised in the second or third year of a five-year plan, and said he expected investment opportunities to emerge in segments such as high-speed rail and subways.

Barings also favours sectors with long-term growth potential including information technology, which accounts for 26.2% of its China select fund, which is the largest of any sector.

“Selected mobile operators are well placed to benefit from increasing telecom data usage following the launch of 3G initiatives across China,” noted Fong. “The fundamentals of the IT sector are also robust given the growth potential of the ever-popular smart-phone market.”

Among the fund’s top 10 holdings are Tencent, Comba Telecom, Kingdee International Software and Sina Corp.