For global investors, now is precisely the wrong time to overlook China’s market potential

PUBLISHED : Monday, 21 May, 2018, 11:05am
UPDATED : Monday, 25 June, 2018, 5:32pm

Asia’s largest producer of giant windmills. The creator of Africa’s favourite cellphones. And the world’s most valuable artificial intelligence start-up.

These are just some examples of the kind of firms that have popped up in China in recent years – the product of a gradual but epochal economic rebalancing that has seen low-tech, heavy-duty manufacturing increasingly superseded by hi-tech innovation and domestic consumption.

This story has been largely beyond foreign investors, whose holdings account for less than 2 per cent of China’s stock and bond markets. But this is starting to change, and in a big way.

The opening up of the mainland’s capital markets has sped up markedly in recent years, most prominently with a pair of “stock connects” linking bourses in Shanghai and Shenzhen with the international finance hub in Hong Kong.

The China Interbank Bond Market Direct scheme was introduced in 2016, followed by a “bond connect” with Hong Kong last July. And a new stock connect could link the mainland with London as soon as the end of this year.

Another major milestone comes on June 1, when index provider MSCI includes more than 200 big-cap mainland-listed stocks – also known as A shares – in its  Emerging Markets Index.

The inclusion shows China is becoming accepted into global capital markets. It could also prompt well over half a trillion US dollars to pour into Chinese stocks in the next five to 10 years, as institutional investors adjust index-linked portfolios to MSCI’s change.

Clearly, investors – be they European hedge funds, pension funds in Australia, sovereign wealth funds from Asia, or ordinary savers around the world – will need to look at what might be a once-in-a-generation opportunity.

China’s equity market is the world’s second-biggest, with more than 3,000 A shares listed in blue-chip-heavy Shanghai and tech-centric Shenzhen valued at about US$8.7 trillion last year. Its bond market is the world’s third-largest.

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On the hi-tech and innovation front, government policies such as “Made in China 2025” have led to spectacular growth in advanced manufacturing, e-commerce, and electric vehicles, as well as the most highly valued AI start-up in the world.

On the consumption front, rising incomes have created investment opportunities in everything from travel services to fiery baijiu.

Chinese companies are also riding on the “Belt and Road Initiative”, a multidecade strategy to increase China’s economic connectivity overseas. The beneficiaries include Transsion Holdings, a little-known Shenzhen manufacturer that is now Africa’s No 1 mobile phone brand.

Efforts to promote higher-value growth that is also good for the environment are set to foster green champions. China’s top wind turbine maker, listed in Shenzhen and in the business for barely 20 years, is now the world’s third-largest manufacturer of renewable energy generators.

To be sure, investing in China can sometimes feel like it’s not for the faint-hearted. MSCI has warned against prolonged suspensions of A shares, and wants to assign environmental, social and governance ratings for stocks on its index.

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The same call has gone out for Chinese bonds. Bloomberg has urged additional enhancements to “increase investor confidence” in the sector.

Such changes will take a bit of time. But longer term, developments that encourage further opening up – such as the MSCI index inclusion – will both strengthen China’s capital markets and help finance its economic transformation.

For Beijing, financial reforms, the opening up of its capital market, and the growing global use of the yuan that comes with that, are all part of the wider economic rebalancing it wants to achieve.

The direction is clear, and the pace is picking up. For investors around the world, the biggest mistake would be to ignore China’s markets and their enormous potential now.

David Liao is president and chief executive officer of HSBC China