Finding the value in Chinese shares: Charts of the week
The most undervalued major market in the world is also one of the most complicated.
Mentioned: Platinum Asia ETF (PAXX), Contemporary Amperex Technology Co Ltd (300750), Global X China Clean Energy ETF (2809), VanEck Global Clean Energy ETF (CLNE), CNOOC Ltd (00883), China Mobile Ltd (00941), Fidelity Asia (13316), Platinum Asia (9894), iShares China Large-Cap ETF (AU) (IZZ)
There are two sides to the Chinese equities story. Optimists argue China offers investors access to the world’s biggest economic success story, one that has lifted hundreds of millions out of poverty and hosts the most unicorns—private companies with a US$1 billion valuation or more—outside the US. Pessimists say years of mediocre equity returns show economic growth has a tenuous relationship with shareholder returns. A closer look reveals there a middle-ground: amid a widespread selloff, certain sectors have proved resilient, a handful have even outperformed global peers.
Deciphering Chinese equity market performance is bedeviled by the variety of indexes available: shares can be listed and incorporated in mainland China, Hong Kong, overseas or some combination of all three. The differences matter. Evergrande, Tencent and Alibaba are all listed in Hong Kong, not the mainland. The MSCI China Index, which includes all share classes is down 34% in the past twelve months, weighed by crackdowns on many Hong Kong-listed real estate and technology firms. By comparison, the MSCI China A Index, which invests only in mainland shares, is down 8.5%.
Breaking indexes into their component parts reveals a few winners. Mainland listed energy, materials and utility sub-indexes are islands of green amid a sea of red. Energy led the pack, up 27% over the past year alongside the global rally in energy stocks. An MSCI index of Chinese financial stocks has outperformed its European equivalent this year, falling 2.7%, compared to a loss of more than 6%.
Nuance doesn’t erase the massive losses investors suffered via broad-market Chinese exchange-traded funds. Thanks to large holdings in Alibaba, Tencent and Baidu, the iShares China Large-Cap ETF (ASX: IZZ) is down 30% over the past year. China exposure helped shred Magellan’s record of outperformance.
However, the state looks after its own. China’s “Red Chips”, state-controlled public-listed companies, have avoided this year’s downturn. These firms tend to be big dividend-payers in value sectors such as energy, industry, consumer staples and utilities. Red-chip tracker, the Hang Seng China-Affiliated Corporations Index, is up 0.8% year-to-date, although longer-term performance leaves much to be desired. Majors such as oil and gas producer CNOOC (00883) and China Mobile (00941) are trading at double-digit discounts to fair value.
State intervention helped create big wins for investors savvy enough to follow policymaker signals. Renewable energy stocks rallied heavily in the first half of last year after President Xi committed China to emissions reductions. Despite falling in this year’s selloff, the US$384 million Global X China Clean Energy ETF (2809) is up 30% over the past year. Flagship Chinese battery maker Contemporary Amperex Technology (300750) is up 61% over the same period, and up 847% over the past five years. By comparison, VanEck's Global Clean Energy ETF (ASX: CLNE) is down 12% since last March.
“In a country when the regulators have a strong hand, you want to go where the government wants to go,” says Dr. Joseph Lai, founder at Ox Capital, an emerging markets equity fund. “If a sector is being reformed and there is a lot of uncertainty, focus on who the winners will be. The uncertainty means valuations get chopped down and that’s where the opportunities can be.”
Policymakers support markets less directly too. Calls for market-friendly policies from top officials on 16 March saw Hong Kong’s Hang Seng jump 16.8% in two days while the mainland CSI 300 added 6.4%.
Navigating government edict and the alphabet soup of share classes gives professional investment managers an opportunity to add value. Morningstar research found three-fourths of Chinese stock funds beat their benchmarks in the 10 years to June 2021, compared to 19% for US active managers.
“China may well be the only major market where a majority of professional investors regularly beat their benchmarks,” says Ben Johnson, Morningstar director of global ETF research.
Local investors have three Morningstar medallist active managers with major exposure to Chinese equities. Hong Kong and mainland listed shares make up between 40% to 60% of the portfolios of silver-rated Fidelity Asia, bronze-rated Platinum Asia (ASX: PAXX) and bronze-rated Aberdeen Standard Asian Opportunities Fund. All three lead the index over a three-year horizon and lag over a one-year horizon.
Optimists see in China the world’s most undervalued major market, with stocks trading at an average 30% discount to fair value. Pessimists spy a value trap as officials lock down swathes of the economy in line with the country’s zero-covid policy. Those taking the middle path should tread, but carefully.