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Why investors should consider China in the Year of the Monkey

The rise of China's middle class makes long-term investment in China a good bet, writes Ben Hurley.

This week, millions of Chinese people are travelling home to welcome the Year of the Monkey with their families.

After a torrid year financially, auspicious money-bringing foods such as fish (which sounds like "surplus" in Mandarin) and spring rolls (which look like gold bars) might form a larger part of the menu than usual.

The economic news coming out of China in the past year has not been pretty. Here in Australia, news headlines have warned us of Chinese economic slowdown and we've seen scenes of turbulent trading on the Shanghai Stock Exchange on the nightly news. Just this week, details have emerged of a giant Chinese Ponzi scheme that was disguised as a government-backed peer-to-peer lending business, fooling 900,000 investors.

It's understandable that ordinary Australian investors might be tempted to run a million miles in the opposite direction, but there are good reasons to take a closer look.

Firstly, the value of most Chinese shares is low right now, so it could be the time to pick up a bargain. There's risk involved, but plenty of potential upside too.

Secondly, for all the talk about the Chinese economy hitting the skids, it actually grew 6.9 per cent in 2015. Sure, it's not the turbo-charged growth China was accustomed to, but it's healthy economic growth by usual standards.


Thirdly, it's about the long game. Investors should remember that China's economy is expected to grow for many years to come. If you're struggling to fill the growth portion of a diversified investment portfolio, it would be unwise to ignore China.

The Chinese economy is in the midst of a transformation that, if all goes to plan, will see it stabilise at a slower pace of growth and rely less on old industries like smelting, manufacturing and building.

Here in Australia, we feel that acutely, in the form of a steep decline in the demand for our once lucrative resources exports. However, the view from China is different.

The big story that is playing out in China is the emerging middle class that will eventually support a much more diversified economy. The OECD predicts the global middle class will climb to 4.9 billion by 2030, up from 1.8 billion in 2009. Two-thirds of this expected growth will come from Asia, and much of it from China alone.

For most Chinese families this Lunar New Year, the dumplings won't be fewer nor the red envelopes stuffed with less money. Real wages for Chinese workers have climbed steeply over the past decade and there's no sign of slowing.

Around the festive table, families might talk about financial products to put their massive savings to better use and the overseas trips they're taking. They'll be exchanging gifts such as sportswear, computer games and electronics, much of it purchased online from home-grown, increasingly global, e-commerce giants such as Alibaba or Tencent.

They have an investment horizon measurable in minutes.

Nick Beecroft, T. Rowe Price

The new growth in China in the coming decades will come not just from China exporting manufactured goods to the world, but also from the 1.4 billion citizens of China becoming members of a consumer economy.

Nick Beecroft, portfolio specialist at American investment firm T. Rowe Price Group's Hong Kong office, says the consumption and services side of the Chinese economy is still "vibrant and strong".

"Sectors like the internet sector, consumables, insurance and healthcare – these are all areas we think will deliver really good growth numbers over next few years," Beecroft says.

Be cautious

This isn't a call to drop everything and go punting on individual Chinese stocks. It is now possible for foreigners to invest directly on the Shanghai or Shenzhen Stock Exchange, but it's not for the faint-hearted.

Many ordinary Chinese investors treat buying and selling shares like a day at the casino, so you would be going head to head with these investors in a zero-sum game.

"They have an investment horizon measurable in minutes," says Edmund Harriss, director of Guinness Atkinson Asset Management.

"Expectations for this group centre on second-guessing government policy: will they cut interest rates, or increase liquidity, or add extra stimulus?"

Then there's the fact that many Shanghai and Shenzhen-listed companies only report their results in Chinese, and corporate governance standards for some companies might not be what international investors would expect.

So not only would you need a huge appetite for volatility, you would also need considerable expertise, ruling out most ordinary Australian investors from the game.

Instead, for the vast majority of people, the best way to access the huge Chinese market is through managed funds – and there are plenty of options.

China exposure via the ASX

AMP Capital's China Growth Fund, which is listed on the Australian Securities Exchange, aims for long-term capital growth by investing in Chinese companies. AMP was the first Australian institutional investor to receive a Qualified Foreign Institutional Investor quota from the Chinese government, which is essentially a quota allocation that allows it to buy Chinese domestic shares, known as A shares.

The fund's ASX shares are trading at a price well below its net asset value, which could mean a strong buying opportunity if sentiment towards China turns.

Patrick Ho, AMP's head of Asian Equities, says Australian and Chinese A shares rise and fall independently, which means that owning some Chinese shares is a good way to diversify your portfolio.

Ho believes the poor sentiment towards China makes for a once-in-a-decade opportunity to buy undervalued shares in key growth sectors, and he laments that most Australians he speaks to can only claim exposure to China through Australian-listed resources stocks.

"I've been in this industry for more than 20 years now, and it's always difficult when you try to persuade investors to get into market when sentiment is low," Ho says. "But subsequently they realise it's an investment they should have made."

While prevented by company policy from naming individual stocks, he is bullish on China's structural growth prospects, saying consumption made a 48 per cent contribution to China's GDP four years ago and is making a 58 per cent contribution now. "But the US is more than 85 per cent," Ho says. "China has been moving in that direction at a gradual pace and there is still a lot of upside potential."

He sees enormous opportunities in lifestyle consumption, particularly tourism and the e-commerce channels that will accommodate it.

Neglected stocks

Another Australian fund is Platinum Asset Management's Platinum Asia Fund. It contains a range of stocks listed in mainland China and also the Hong Kong Stock Exchange. Portfolio manager Dr Joseph Lai says there are "neglected" stocks that can be picked up at attractive valuations.

"Particularly in Hong Kong, some shares are now very cheap," Lai says.

"The Hong Kong market's Hang Seng Index is very close to being below book value. I think it's the time to buy into quality names with a good position and long-term growth. Not a lot has to go right for these stocks to go well, and quite a lot has to go wrong for us to be punished at these levels."

Most of his fund's stocks are in consumer-related sectors. The fund owns shares in Kweichow Moutai Company and Jiangsu Yanghe Group, which produces a range of famous alcoholic drinks including the pungent sorghum-based liquor Maotai.

Another stock Lai is bullish on is Tencent – the Hong Kong-listed Chinese investment company that holds a range of prestigious internet properties, including social network WeChat and taxi app Didi Kuaidi.

T. Rowe Price, which deals more with institutional investors than retail investors, also owns shares in Tencent.

"These Chinese internet companies are incredibly advanced in what they offer to consumers, far more advanced than some of the apps and online tools we are used to using in the West," says Beecroft. "So they have been incredibly disruptive to the traditional economy in China and we think that will remain the case going forward."

Choose your stocks wisely

Beecroft says the bad news coming out of China affects some stocks more than others.Therefore, he recommends investors choose an "active" fund – one where a fund manager chooses the stocks – rather than a "passive" fund where it mirrors a market index.

"We think there are some really fantastic stock opportunities in the Chinese market but there are also big parts of the market that we think are places we don't want to be investing in," Beecroft says.

"If you're investing in an index product you're going to have exposure to those lower growth and arguably more troubled sectors."

He also recommends looking at Asia more broadly, rather than just China.

"China is a very big part of the Asian opportunity but there are great companies across Asia that we feel can generate good returns for investors over the long term," Beecroft says.

"You might have a third invested in Chinese companies, with the rest in South-East Asia, India, South Korea, Taiwan where there are also great businesses."

And you can also look at a more indirect exposure to the Chinese growth opportunity by investing in international companies that are active there, including several non-resources companies on the ASX.

China's economy has its doubters, of course.

The question is whether most of the bad news is already reflected in stock prices, or whether there is some really bad news yet to come. If the answer was clear then there would be no opportunity.

But even if China exposure only forms a small part of the risky end of your portfolio, taking a long-term view is the safest bet.

How to buy Chinese shares

Buying into a fund is the most realistic way to gain China exposure for most investors. But for those who want to invest directly, the process is relatively simple.

Non-Chinese investors can buy into the shares of Chinese companies traded in Hong Kong, the United States and Singapore.

They can also access Chinese domestic shares via a new access mechanism known as the Shanghai-Hong Kong Stock Connect, which allows foreigners to buy Shanghai shares via Hong Kong.

Many Australian brokers will be able to organise this through a broker in Hong Kong.

Exposure via Australian shares

Closer to home, a number of ASX-listed companies are tapping into China's consumer growth story.

  • Bellamy's Organic (ASX:BAL) produces food and formula products for babies and toddlers, and has experienced strong demand for its products in China, where parents are highly suspicious of local producers. It was one of the most successful businesses on the ASX in 2015. Its share price has fallen in recent weeks but is still far ahead of its ASX debut in August 2014.
  • Blackmores (ASX:BKL) has also seen a recent slide in its share price after steep growth through 2015 on the back of China demand. Traditionally focusing on vitamins, it is launching a new line of baby formula products to keep up with the insatiable demand from Chinese parents.
  • Treasury Wine Estates (ASX:TWE) will be providing a lot of the wine on Chinese tables over Chinese New Year. The owner of famous brands including Penfolds, Lindemans and Rosemount, it recently released earnings guidance above what analysts were predicting.
  • ANZ Banking Group (ASX:ANZ) plans to expand its customer base in China and issue longer-term loans to top customers, aiming to increase what has so far been a relatively small retail presence in China.