Multi-Year Up Cycle for Chinese Equities


20 Jul 2018


As concerns over an impending trade war between the US and China hots up, one fund manager is upping allocations to Chinese banks and financials.

Current negative sentiment is driving the market down, generating opportunities to buy on weakness, something that attracts Lilian Co, portfolio manager of the EI Sturdza Strategic China Panda Fund with nearly $200m of assets under management. This year she has increased the weighting of financials, including Chinese banks and property companies, to account for over a quarter of the entire portfolio’s allocations.

“I think this is a big change for the fund because we didn’t have anything in Chinese banks for a few years,” she said. Banks are displaying attractive valuations and yields, trading at below price to book value with a decent dividend yield at present. “We believe the asset quality of banks is actually improving with the stable economy,” she added.

Banks and property (included in the financial sector) are in a consolidation phase as they absorb stricter rules on lending and general regulations that should strengthen both sectors as smaller players disappear or are taken over by larger ones.

This analysis also fits with the policy changes Ms Co sees playing out in China. The government is addressing company debt levels while keeping its monetary policy loose enough to encourage growth rather than harm it. At the same time shadow banking is shrinking while mainstream banks are beginning to lend again but with more restraint.

Ms Co, who is based in Hong Kong, began allocating to properties in 2017 when valuations were cheap with attractive yields. This year she has continued to hold positions in Chinese property as this sector also is entering a period of consolidation with large players once more in favour with the banks and gaining market share as smaller players exit the sector.

This analysis is reflected in the latest Chinese GDP figure, with the economy expanding by 6.7 per cent in the second quarter. This was the country’s slowest growth since 2016. However, annual GDP growth is still on target to end 2018 at around 6.5 per cent. The apparent sluggish pace (at least for China) is the result of the Government efforts to slow infrastructure investment.

These are important considerations for a fund that focuses on allocating to stocks with a potential of reasonable price growth. “When it comes to investment ideas, we always look for mispricing opportunities because we think that earnings surprises, positive or negative, are the major drivers for stock de-rating or re-rating. Mispricing opportunity is what we target,” noted Ms Co.

Ms Co also sees high levels of growth momentum attached to consumer discretionary stocks as the emergent Chinese middle class moves into higher quality goods and services, including entertainment, tourism, casinos and gambling. “Chinese consumers don’t just consume more, they look for better quality when it comes to consumption of goods. We are overweight in the consumer discretionary sector and expect this to be the case over the next 12 months at least,” noted Ms Co.

Another sector Ms Co is keeping an eye on is handset equipment. Although the component sector suffered as a result of poor Apple sales in recent months, it is expected to pick up as new products are launched in the second half of this year. With 5G coming to China in 2020, component manufacturers are already starting to develop new products and investor attention will focus on this sector once more.

Overall, China stocks are still cheap, with a 13x price/equity ratio compared to developed markets. The government has a clear blueprint of how it wants to drive the economy with the “made in China 2025” strategic plan. Ms Co’s view is that the country is on a multi-year up cycle. This means long-term investors should be buying quality, growing companies while they are still undervalued.

Author: Margie Lindsay, Editor, Alpha Journal

The views and statements contained herein are attributable to LBN Advisers Limited in their capacity as Investment Adviser to the EI Sturdza Strategic China Panda Fund and are valid as at the date of release.