Private companies must form a bigger proportion of China’s benchmark equity index if it is to stop underperforming, argues Andy Rothman, investment strategist at US fund house Matthews Asia.
Broad China indices have performed poorly over the past few years and are likely to continue doing so unless inefficient state-owned enterprises (SOEs) are delisted and private companies are added to the course, he suggests.
The CSI 300, which represents stocks on the the Shanghai and Shenzhen exchanges, has slumped 6.65% year-to-date and 30% over the past three years. The FTSE China A50, which covers large-caps, has lost 5.44% and 27.4% over the same periods.
Listed mainland companies are unrepresentative of the economy because many are SOEs, Rothman notes. Privately owned non-listed names employ 80% of China’s workforce and account for 70% of the country’s industrial sales and investments.
Further, broad indices are skewed towards the “old economy”, with dominant sectors including telecoms, infrastructure and oil and gas, he argues, while firms such as technology companies that are likely to benefit from emerging economic trends are under-represented.
“There has to be a major restructuring of listed companies. I think that will happen, but not in the next year or two,” says Rothman.
Hence, while China’s economy is in good shape, now is not the time to invest in a broad country benchmark — better to wait until indices have been restructured, he suggests.
And Rothman doubts that the pending Shanghai-Hong Kong Stock Connect will bring an improvement in performance on the back of increased inflows, since the two cities’ main indices contain similar names.
Morever, though mainland stocks have underperformed, their weakness does not reflect the state of the country’s economy, he adds. “Most investors are too pessimistic about China. They have over-emphasised the country’s slowdown.”
Rothman, who frequently travels to China to talk to owners of private companies, says the risk of an economic meltdown because of a burst property bubble or local government debt crisis is not as high as many envision.
He is less worried than many observers because all local government debt is backed by the central government, which he argues has the resources to cover it.
Sector-wise, like many investors, Matthews Asia is overweight consumption because China's consumption story is the best in the world, says Rothman. In spite of a high savings rate, China has the world’s fastest growth rates for consumption and for retail sales, he notes.
And consumption will continue to be fuelled by expanding personal incomes, he says. Over the past decade, real income in China rose by 130%, while in the US real disposable income rose by only 18%. Growth may slow, adds Rothman, but it will continue to be robust.