Investing in China in the Year of the Monkey: Investors need to be nimble and smart

4th February 2016


William Fong, lead manager of Baring China Select and China Growth funds explains why he believes investors will need to be smart as well as nimble if they are going to beat the Chinese market in the Year of the Monkey…

The early weeks of 2016 have presented investors with considerable volatility across global equity markets, and China has been no exception.

The MSCI China Index closed January 12.7% lower in US dollar terms, slightly behind the MSCI Emerging Markets Index. This comes on the heels of a weak twelve months, which have seen the market drop almost 23% on the same basis.

There is no single reason for the decline in the market, although the decision of the Federal Reserve to raise short-term interest rates, concern over the potential for further weakness in the Renminbi and Hong Kong dollar, and the unsettling effect of the new “circuit breaker” in the Chinese market have all played their part.

In our view, the turmoil in the market has created an opportunity for nimble investors prepared to take a longer term view. While further volatility cannot be ruled out, our assessment is that the weakness in the market has been driven primarily by sentiment rather than fundamentals.

In focusing on the exact number, the fact that China remains one of the strongest contributors to world growth has sometimes been overlooked.

The government’s extensive reform programme – including the abolition of the “one child” policy from 1st January – has also not yet been given the credence we think it deserves.

The extent of the changes in China’s economy in recent years and the emergence of new growth drivers there present an attractive long-term investment opportunity, in our view.

Identifying long-term winners

Our investment strategy has long been focused specifically to benefit from the changing nature of China’s economy and the growing importance of the service sector.

When assessing companies, we look for potential for growth over the next five years. That’s further than most other managers, and something that we think allows us to identify the long-term potential of many companies early.

We also look for measures of quality, such as robust balance sheets, experienced management teams with a track record of delivering value for shareholders, and a strong franchise.

Companies like this should be less susceptible to shorter-term volatility and possess the potential to strengthen their market position over time.

We like beneficiaries of rising consumption and technological outfitting as Chinese companies move up the value chain.

We also like “New China” brands that are able to compete internationally. These include companies such as Tencent, the technology giant which runs WeChat – China’s largest mobile chat network – and Sunny Optical, one of the leading makers of optical lenses, well positioned to benefit from growth in advanced driver assistance systems in cars.

A strategy for changing times

With share price valuations having moved quite sharply in recent weeks, we have also taken the opportunity to re-assess companies we previously liked, but where we felt the price was too high.

This includes Guangdong Investment, the utility company which supplies water to Hong Kong, Shenzen and Dongguan, which is benefiting from increased demand as a consequence of population growth as well as the increasing recognition, led by the authorities, of the importance of the environment and pure water.

We have also researched and invested in a number of Chinese entertainment groups. Our analysis suggests that box office revenue from films in China will overtake the US next year as more and more people go to the cinema and more Chinese-language films become available. Five of the top 10 highest grossing films in China are domestic productions, and we think this trend will continue.

With valuations markedly lower than they were at the end of 2015, we are confident that the companies we are invested in have the potential to deliver strong returns over the medium to longer term.

While we cannot rule out the possibility that the mischievous monkey will bring further volatility in the short term, we would also emphasise that volatility creates opportunity. With the right approach, investors could still see potential for a little “monkey magic” in 2016.

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