China’s equities and bonds are still undervalued as investment opportunities
Lilian Leung says although China is heralded as a success story for its growth, investors don’t fully appreciate the potential of its financial, energy and bond markets over the next few years
China is well known globally as a growth story, but investors may be overlooking its vast income potential across both equities and bonds. With ongoing corporate reform and the MSCI China A-shares inclusion in June, as well as the local currency bond inclusion in Bloomberg Barclays Global Aggregate Index next year, it is expected that the income universe will further expand and attract more attention globally.
For a few years now, the Chinese government and regulators have been encouraging companies to pay out more as dividends and a dividend culture is now building up. In the 2017 results season, companies listed in Shanghai broke records in terms of dividend distribution – total amount distributed; the number of companies paying out dividends; and, the dividend-payout ratio.
Across both onshore and offshore China equities, some 60 to 70 per cent of the companies are paying a dividend and, based on current valuations, more than 500 names are trading at or above 2 per cent dividend yield. We’ve seen encouraging and interesting examples in the past 12 to 18 months of home appliances, insurance and energy companies raising their dividends.
Going forward, investor demand is also expected to be a force to reckon with. With more foreign investors coming in, long-term local institutional investors taking part and pensions seeking income sources, the appetite for steady dividends should underpin the growing tailwind for equity income investing in China.
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Specifically, financial services offer an interesting dividend opportunity, particularly banks. Steady economic growth has helped banks keep asset quality under control. Rising interest rates also imply banks may start to enjoy higher net interest margins, providing a better earnings outlook. After all, they are attractively valued with decent dividend yields. Outside banks, increasingly affluent Chinese consumers are also underserved by insurance providers, and rising incomes should prompt the need for more insurance coverage, supporting dividend growth.
The dynamic consumer sector is another fertile ground. Thanks to economic rebalancing and the growing consumption power of the largest middle-class population in the world, consumer upgrades have now become a secular trend in China, fostering a great environment for leading consumer companies. A lot of exciting opportunities can be found in the consumer discretionary sector, including electronics and autos, as well as staples such as food and drink.
As China’s urban population grows, cities are expected to more than double their demand for energy and in particular from more environmentally friendly sources. Required modernisation will create opportunities for energy, water, sanitation and transport infrastructure, while tighter environmental requirements will help leading players with better efficiency to generate steady cash flows and be able to pay dividends to investors.
For bonds, looking across the three major categories – onshore and offshore Chinese bonds, and offshore US dollar bonds – one major theme is the rapid liberalisation of the market for foreign investment.
Foreign investors have yet to fully embrace China onshore bonds for a number of reasons. The market is not yet widely incorporated in all global indices, access still requires some technical set-up, market liquidity can be limited and there are lingering concerns about financial deleveraging.
That said, in March 2018, Bloomberg announced it will add Chinese yuan-denominated government and policy bank securities to the Bloomberg Barclays Global Aggregate Index, beginning next April. This is one of the three major global bond indices the other two are expected to follow suit. This is a milestone in terms of the global recognition of the China bond market, as the inclusion complements the Chinese yuan as a reserve currency in the special drawing rights basket. This has the potential to attract over US$250 billion in inflows from global bond investors in the next few years.
More importantly, investors dipping into the onshore yuan market have the flexibility to alternate between onshore and offshore markets, depending which provides better value.
Lilian Leung is a fund manager of JPMorgan China Income Fund