Despite recent fluctuations, the Chinese market still offers growth opportunities.
As a result, there are two ways to approach investing in the current climate, says Kenrick Leung, director of investments at Amundi Asset Management in Hong Kong, and manager of the Renaissance China Plus Fund. You can either “become a victim of volatility by selling low and buying high, or you can focus on companies that have long-term goals, competitive advantages and clear cash flow streams.”
Looking at China’s economy and market, he adds, it’s easy to come up with top-down themes and strategies, such as environmental or healthcare plays. “But within those specific themes, it’s generally very difficult to find companies that have competitive advantages.”
These days, Leung is most optimistic about the e-commerce space. He favours companies such as e-commerce giant Alibaba and China’s largest search engine, Baidu, which both have good market share. Also, their competitors face barriers to entry. He explains, “These companies used to trade at 30 or 40 times. Their growth has slowed down a little because of economic challenges, but we’re still talking about 30%-plus growth. And, because of the sell-down, some of these companies are trading at 30% to 40% down from the peak. Before, we thought they were overvalued,” but now valuations are attractive.
In the Internet space generally, there’s a lot of opportunity, says Leung. “Companies that have good niches [and] companies with long-term growth prospects are very much intact. And this space is being consolidated by some of the leaders,” which include Alibaba and Baidu.
When circuit breakers backfire
Recently, China’s Securities Regulatory Commission (CRSC) implemented and then suspended a circuit breaker mechanism that was designed to manage the volatility of the Chinese A-share market. Unfortunately, the mechanism backfired and triggered more volatility.
Leung says, “The circuit breaker mechanism only applied to A shares, not H shares. The way the mechanism worked was when the market fluctuated 5%, trading would be suspended for 15 minutes. When it resumed, if [the market] fluctuated 7%, [trading] would be suspended for the day.”
However, this type of volatility occurred in the first week of 2016 and investors were unsure what to do, he adds. “The circuit breakers halted exchanges for 15 minutes after a 5% drop in the CSI 300, and [then] for the rest of the day after a 7% retreat. [There were] aggravated losses as investors scrambled to exit positions before getting locked in.”
As a result, says Leung, “This rule has been suspended. It created the opposite effect [than intended] since it actually created more volatility. When people saw [markets] would suspend trading after a 5% drop, they rushed to sell if things were already down 3%. And when they resumed trading, rather than being locked up for the day, people sold.”
So, “It turned out to be a pretty ill-conceived plan, and the CSRC understands that now. One of the biggest risks to the Chinese economy lies in policy mistakes—and this was a policy mistake.”
Since the withdrawal of the circuit breaker mechanism, analysts have suggested that Chinese regulators could set higher thresholds than 5% and 7% to avoid unnecessary trading disruptions.