Funds returning to Chinese stocks as reforms seen improving prospects

PUBLISHED : Wednesday, 09 April, 2014, 2:49pm
UPDATED : Wednesday, 09 April, 2014, 2:49pm

China’s first-ever domestic bond defaults, a weakening currency and slowing economic growth are not normal buy signals, but money managers see them as a sign that the country’s reform drive is genuine and that stocks offer long-term value.

Attracted to stock valuations near their lowest in at least a decade, investors have pushed the Shanghai Composite Index up about 6 per cent, and an index of the top mainland listings in Hong Kong up 13 per cent in a rally that started roughly three weeks ago.

While investors are not convinced the recent bounce in Chinese assets will blossom into a true rally, they said the sheer scale of Beijing’s financial sector reforms would be positive in the medium and longer term.

“Things are heading very much in the right direction,” said Bill Maldonado, Asia-Pacific chief investment officer for HSBC Global Asset Management.

“What would you call the widening of the currency bands? What would you call the way that that default happened? What would you call the increase in quotas? All these things are clear evidence of reforms,” Maldonado said.

HSBC is overweight on China in its regional portfolios.

Since unveiling an ambitious reform blueprint in October, China has embarked on reforms including overhauling its bloated state-owned sector, widening the currency’s trading band and increasing investment quotas in a push to allow market forces a greater say in its markets.

Those reforms have included allowing smaller companies to default, with first domestic debt default recorded last month.

This has spooked many credit investors, but money managers said this would lay the foundation for sustainable economic growth and possibly higher stock prices in the near term.

A report from HSBC last month said stock mutual funds had raised their exposure to Chinese equities to near five-year highs, significantly turning overweight on China from being underweight three months earlier.

Another reason for this shift is that Chinese equity valuations now look cheap after a wave of aggressive selling early in the year. Investors pulled out about US$1.8 billion from China-focused equity and exchange-traded funds in the first quarter, according to Lipper data.

Andrew Swan, head of Asian equities at the world’s biggest money manager, BlackRock, said the reforms added stability and better growth prospects and would improve the way companies are managed in China by allowing market forces to direct credit to the most productive sectors of the economy.

Even after their recent bounce, Chinese equities are still 50 per cent below their April 2007 peaks. The IBES MSCI China Index trades at 1.33 times book value, near its cheapest levels since Thomson Reuters Datastream began compiling the data in 2004, and more than 77 per cent below its 10-year median. The index trades at 8.3 times forward 12 months earnings, 26 per cent below its 10-year median.