Focus on domestic matters
Advisers need to look inside the mainland to make sense of its clout, writesJohn Cremer
The growth of personal wealth on the mainland and the attractions for overseas investors will see its financial sector continuing to evolve along international lines.
However, the country's economic clout and policy outlook will determine the pace of change in areas such as market access and fund flows, exchange rates and the approval of new investment products. Interpreting the domestic agenda adds complexity for high-net-worth individuals and their advisers.
"We are relatively cautious on equity-oriented themes in China, especially recent sources of growth such as property, infrastructure and banks," says David Pinkerton, chief investment officer of Falcon Private Bank. "We see a shift occurring towards more internal consumption driven themes and believe good long-term fundamentals there will have 10-plus years of growth."
This would benefit not just suppliers and retailers of consumer staples, but also international brands, such as L'Oreal and Prada, that have tapped into the luxury end of the mainland market. More widespread wealth and an ageing population should also boost the revenue and results of companies in the health care and technology sectors. In contrast, the traditional industries which propelled China to its position as an export superpower can't expect to avoid the consequences of global slowdown. They face a "pause" of uncertain duration.
"An important point we emphasise to high-net-worth clients in China is they may have built wealth through concentration in one industry, but it is best preserved through diversification," Pinkerton says. "We encourage them to go beyond national borders, look to other emerging markets with good growth records, and have some participation in gold as a currency hedge."
For "outsiders" aiming to diversify into China, a usual recommendation is to steer away from investments, such as real estate and property, exposed to macro action and systemic policy changes. An alternative is to back initiatives which, for example, bring power and refrigeration to rural areas or allow for energy storage.
"Those are the types of company we like to invest in," says Swiss-based Pinkerton. "You have to be careful, though, about investing in a story - say solar power companies - that you come to too late and where the margins are getting compressed."
Regarding prospects for the yuan becoming an international reserve currency, he believes the Chinese government can continue to build a compelling case.
"There are still many hurdles before the renminbi becomes a realistic alternative to the dollar, yen and euro. But those hurdles are getting lower as concerns about the euro do not seem to be [easily] fixed."
For Lim Say Boon, chief investment officer for DBS Bank, the poor performance of mainland equity markets presents an opportunity. With indices in the United States and Germany close to 52-week highs, there is a strong likelihood of additional funds flowing to China, as individuals and institutions see lower valuations and a suitable entry point. In parallel, the high risk premium placed on Chinese equities should begin to fall.
"This rally should have legs as global investors are only gradually beginning to reverse their underweight positions on the China market," Lim says. "We believe that, after hitting a trough, there should be a strong rebound in earning growth for more than one-third of the sectors in the HSCEI [Hang Seng China Enterprises Index]. Indeed, we forecast earnings of non-financials will grow 20.9 per cent next year."
The basic reasoning is that the negative earnings outlook, which has been the main drag on the market, is mostly priced in. Announcements about spending on infrastructure show an integrated plan for investment in fixed assets. This will help to build connectivity between mainland industries and regions, supporting the relocation of manufacturing while upgrading transport and services inland.
Lim expects Hong Kong to remain important for playing the China investment theme, but notes the expansion of the Qualified Foreign Institutional Investor (QFII) quota will enable overseas investors to gradually increase participation in A-shares. They should be on the lookout for long-term opportunities in auto stocks, housing, food retailing and environmental solutions.
"Widening the yuan's trading band means there will be greater two-way volatility," says Pearlyn Phau, managing director and head of consumer banking for DBS Bank (Hong Kong).
"The yuan is likely to show moderate long-term appreciation because of China's current account surpluses and moves to expand offshore usage. To diversify, it makes good sense to have part of one's portfolio denominated in renminbi."