This is a sponsored article from Allianz Global Investors.
The global economy and financial markets have been hit hard by the COVID-19 pandemic, with not a single market left unscathed. In the first quarter, while European and US stocks bore the full brunt of COVID-19, Chinese equities showed much more resilience. The numbers speak for themselves: Chinese equities posted a loss of 10% in 1Q20, US stocks dropped 20% and European shares shed 23%.
While most of the world is struggling to contain the pandemic, China’s economy has turned a corner and is rebuilding momentum — with companies restarting operations and business activities gradually recovering. Pent-up demand by consumers and economic stimulus plans have boosted markets. Supported by optimistic local investor sentiment, the daily trading volume in China is currently higher than that of all other MSCI emerging market constituent countries combined.
Structural transformation process
2020 also marks the final year in China’s 13th five-year plan, with one of the key goals being to double the country’s GDP between 2010 and 2020. To achieve this, China will need to deliver a GDP growth of 6% this year. Against the backdrop of the continued easing in the form of both monetary and fiscal policies, the question naturally drills down to which areas of the economy will drive the country’s potentially significant growth story from here.
As China’s economy matures, its growth rate is inevitably slower than it used to be, but it is still one of fastest rates worldwide.
In the meantime, China is undergoing a structural transformation, reshaping itself from an export-oriented economy to a domestic consumption-driven one. With larger and larger revenues of Chinese companies being generated domestically, the Chinese market is showing a lower and lower correlation to external turmoil. Conversely, China’s unique economic, political matters and policies are playing a more important role on the capital market than ever before.
In an economy where self-sufficiency is gaining in importance, some long term structural growth trends are shifting the priorities of society, driving digital innovation and redefining business models in China.
As a typical example, China’s rapid technological advances have been instrumental in the country’s structural transformation process. The sector’s resilience and prowess were even amplified during the COVID-19 lockdown period.
Although the risk of trade conflict may exert some downward pressure on the economy, it has also reinforced China’s determination to accelerate the self-sufficiency transformation process.
This trend towards the “new economy” is irreversible. Characterised by a more vital role of domestic consumption and high value-added sectors — such as tourism, entertainment, healthcare equipment, industrial automation, new energy vehicles, biotech, software and new materials — this is a trend that no investor can afford to overlook.
Foreign investors catching up
Currently, China equities, especially China A-shares, are significantly under-invested by global investors. Although the overall China economy represents 15.8% of global economic output (the data as of 2018), the market capitalisation of China A-shares as a percentage of global equities stood at only 9% (data as of 2019). As a whole, foreign investors only account for a low or mid-single digit of the domestic stock turnover.
However, as external capital flows are gradually becoming a more important market influence, the low representation of China equities in global stocks can play to the advantage of foreign investors in China. The opening of the China A-share market to global investors — as well as the subsequent growing inclusion of a much larger number of Chinese companies in widely used equity indices — is set to materially improve the sophistication, efficiency and institutionalisation of China’s equity market, because large amounts of capital are expected to flow into the market over the long term.
MSCI has begun adding China A-shares to its MSCI Emerging Market Index and MSCI ACWI Index. After the rebalancing in late 2019, A-shares have a weight of 0.5% on its flagship ACWI index and 4% on the Emerging Markets index. With much room for growth, the road to full inclusion for Chinese equities is likely to provide a unique opportunity for global investors.
Great opportunity despite risks
Considering China equities’ strong growth momentum and low correlation to global financial markets, there is little doubt that adding China equities may help investors generate strong return potential — while diversifying their overall portfolios. Yet, in a less efficient market, such as China, being active and selective is always key, and simply increasing allocations to those indices may not be an ideal way to broaden China exposure.
While the China A-share market represents a tantalising opportunity, it carries its unique risks. For example, 80% of the daily turnover of the market is driven by retail investors, who are primarily focused on chasing short-term trading profits. Also, local equity analysts in China tend to be less experienced than those in developed markets, leading to a higher frequency of earnings surprises than in more mature markets. In addition, the regulatory environment is evolving at a fast pace, and remains fairly unpredictable.
All this contributes to higher volatility and greater dispersion of performance, as well as higher sector rotation for China A-shares, which has made those high-conviction active managers stand out in identifying losers and winners.
Driven by insightful market views, excellent market trends identification and strong stock selection skills, Allianz Global Investors’ two China funds — Allianz China A-Shares and Allianz All China — have been outperforming their benchmarks since launch. Risk management too is a key element of the firm’s investment approach. Even during the volatile period of 1Q20, those two funds still managed to outperform their benchmarks.
Outsize return potential
With growth, quality and valuation as its three key criteria for selecting stocks, Allianz Global Investors continues to favour companies that can benefit from policies that are set to advance national competitiveness or support economic growth.
“We believe that active management can help investors to properly – and wisely – exploit the China A-shares market’s inefficiencies to generate potential outsized returns in general, and alpha in particular,” Anthony Wong, portfolio manager at Allianz Global Investors concluded.
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This is a sponsored article from Allianz Global Investors.