Aberdeen Asset Management fund managers are fearful of a China banking crisis, but see opportunity in Hong Kong-domiciled firms exposed to Greater China consumption.

Asian equities manager Kathy Xu argues one of the biggest downside risks to China’s stock market this year is the country’s shadow-banking, or private lending, system. As a consequence she is bearish on the mainland banking sector.

“This area is not transparent nor strongly regulated enough,” she says. “If the shadow banking [system] burst, we worry what banks would have to pay the bills.”

China’s shadow-banking sector is enormous, encompassing trust funds, wealth management products (WMPs), products from securities firms, underground lending and local government financing vehicles.

Together it is estimated these account for Rmb22.8 trillion ($3.6 trillion), or 44% of China’s national GDP.

Only yesterday, China Banking Regulatory Commission (CBRC) chairman Shang Fulin reiterated that WMPs run by trust companies and banks do not fall under shadow banking because they are regulated. The CBRC had already stepped in after fears were voiced about a giant ponzi scheme.

But fund managers are mindful of the Lehman Brothers mini-bonds scandal that blew up in Hong Kong, given that banks were chief distributors of those ill-fated products.

Xu notes that WMPs lack transparency, with some even venturing into China’s under pressure property sector, and suggests they pose a great risk to the broader banking sector as a whole.

Nicholas Yeo, head of equities (China/HK) at Aberdeen Asset Management, adds to the concerns, noting that Chinese banks have not yet experienced a credit cycle, making it hard to know how well they can manage the risk of non-performing loans, particularly given the lack of data and track record.

But Yeo, who runs the firm’s flagship $2.8 billion Chinese equity fund, talks up Hong Kong-domiciled firms exposed to the Greater China consumption story.

“The key thing is the valuations of these companies are not as ridiculous as mainland Chinese consumption-related ones,” he says.

On the back of a sluggish A-share market for most of last year, Yeo had expected to see the valuations of good companies, which used to trade at around 20x forward earnings, trend down.

However, the market rebounded in the fourth quarter, with some consumption names returning to 30x. “The better ones have not yet de-rated enough in terms of valuation,” Yeo stresses.

He believes that investors have become too indulgent with “Chinese consumption” plays, using the term as a catch-all and driving up valuations to the point where they have been over-paying for growth.

As a consequence he favours Hong Kong retailers and consumption plays either with direct exposure to China’s growth, or those that benefit from its consumer power.

“How we play [China] consumption is: one, [Hong Kong companies] that have business in or are expanding into mainland China; two, millions of mainland tourist shops [in Hong Kong], so indirectly there is [Chinese] consumption.”

Yeo cites as an example Hang Lung Properties, a Hong Kong-listed developer with shopping malls across first- and second-tier cities in China where wealth is growing strongly.