Between the parry and thrust of the US-China trade talks, uncertainty over economic growth rates, US interest rate policy and China’s credit reform programme, it appears US investors, more so than their global peers, have put increasing amounts of cash to work in China region equity funds. And while they have been rewarded by share prices rallying to one-year peaks, several US fund managers who invest in Asia – and China more specifically – note that there is still a reluctance to put more money to work in Chinese-based companies. “China as an asset class: at what point will people take it more seriously? Is it time to dedicate an allocation toward China?” said Andrew Mattock, San Francisco-based portfolio manager for Matthews Asia Funds. “Are we at a tipping point where people allocate to China like they did to emerging markets 10 to 15 years ago? I think it is long overdue.” Investors put a net US$1.87 billion into US-based China region funds in the first quarter of 2019, after a US$4.88 billion inflow of fresh capital for all of 2018, according to data from mutual fund tracker Lipper from Refinitiv. “Total flows in 2016 and 2017, among all China-focused funds on a global scale, were not quite as strong as they were in the United States,” said Tom Roseen, head of research services at Lipper. On a global basis in 2016, China-region-focused equity funds and the subset of US-based China region funds had net outflows of US$8.8 billion and US$4.35 billion, respectively. US trade war forces firms to rethink private investment However, in 2017, the two diverged, with the US-based funds taking in a net positive US$340 million in 2017 versus an overall net outflow on a global scale of US$13.6 billion that year. On a global scale, China region funds took in a net US$33.3 billion last year, the Lipper data shows. “Last year there was a fear of the worst of all situations,” said Arjun Jayaraman, portfolio manager at Los Angeles-based Causeway Emerging Markets Fund. “That there would be no deal on the trade front, there would be a dramatic slowing of the Chinese economy. To the extent that has not materialised, it has been a positive.” US Trade Representative Robert Lighthizer and US Treasury Secretary Steven Mnuchin are expected to travel to Beijing this month to continue talks, injecting hope into the markets that a deal will be reached and the uncertainty hanging over global markets removed. A major bone of contention remains Washington’s insistence that Beijing cut subsidies given to Chinese companies. The lingering worries, however, are not just over the trade war, which began on July 6. As investors have described, the Chinese market is emerging from a period of financial re-engineering of its credit sector. US investors see bargains in Chinese market bloodbath and trade worries “China was going through a pretty difficult period last year even before the trade disputes,” said Brian Herscovici, chief investment officer of USAA Managed Portfolios, based in San Antonio, Texas. “They were implementing supply-side reforms. They were curtailing the shadow banking system and removing credit from the system. In addition to that, corporate earnings were doing poorly in China. All these fundamentals were getting intertwined with the sentiment. “They took their medicine last year and reduced their shadow banking sector,” he said, adding that economic growth was relatively strong and “they can take their foot off the brake”. Last year, Beijing moved to slow or reduce the size of leverage in the economy. This resulted in fewer options for smaller firms to secure credit, putting a drag on the economy and sparking concerns it would slow too rapidly. Those fears were somewhat allayed by the 6.4 per cent first quarter GDP data, which came in at the high end of expectations. Another factor that has contributed to positive sentiment for China equities was the pause in tightening US monetary policy. This takes the pressure off Beijing’s management of the foreign exchange rate, a crucial influence on the nation’s ability to export its goods and services. Brighter outlook for yuan and foreign investment as US-China trade war deal nears However, the size of China’s domestic debt remains a long-term negative, said Binu George, portfolio strategist at GMO in Berkeley, California. “The Chinese leadership is extraordinarily aware of this,” said George, who said his firm was roughly neutral on Chinese shares when measured against the benchmark MSCI China index. “The fact that the government has embarked on a stimulus means we are not where we were in 2018, and so we are a bit more positive. But still, we have concerns for the long-term,” he said. In the short term – meaning, this year – the increased weight of Chinese shares in benchmark MSCI indices is likely to keep the flow of money into China region funds going, fund managers said. Last month, the stock market index compiler MSCI said it would quadruple the weighting of Chinese stocks in its global benchmark indices in three steps, which will conclude in November. At that time, Chinese stocks will represent 3.3 per cent of weighting for the MSCI Emerging Markets Index. Rising pressure on China state-owned firms to boost transparency Chinese equities are still cheap, Matthews’ Mattock thinks, even as China’s stock markets traded at 11.5 to 12 times earnings versus nine times their earnings a year ago. According to Lipper, among US domiciled funds only, those focused on China have returned 23.15 per cent this year, outpacing emerging market funds by 10 percentage points and India region funds by nearly 4½ times. Portfolio managers point to the increase in Chinese per capita incomes as a major factor in putting money to work in consumer consumption areas of the market. The World Bank’s gross national income per capita figures for China, on a purchasing power parity scale, as of 2017, were US$16,760 versus US$6,880 in 2007. Long-time China investor Rob Lutts, president and chief investment officer of Salem, Massachusetts-based Cabot Wealth Management, said he thought “the general attitudes toward China, among investors, is still in the ‘avoid’ category”, but he saw a lot of value in the nation’s equity markets, with insurance among his favourite sectors. “When incomes go from US$8,000, US$12,000 towards US$25,000, you go from taking care of basic needs to start thinking about buying cars and homes, and that brings insurance,” he said, adding that he liked insurers Ping An Insurance and AIA Group Ltd. “Investing in those two companies today,” he said, “is like investing in Prudential in the 1940s in the United States.”