An irresistible destination for global investors

With all its pandemic ramifications, the year that was－2020－may have gone down as an annus horribilis for everyone, but it also has been very rewarding for foreign investors who bet on Chinese equities.

For global investors, China's A shares provided a sort of resilience that proved increasingly scarce elsewhere as the world's financial markets progressed through the COVID-19-savaged 2020.

Take China's benchmark CSI 300 Index, which rose 22 percent to 5000.02 points from Jan 1 to Dec 24.During the same period, the MSCI ACWI Index, a key global equity index, was a bit of a contrast as its growth of 12.75 percent in US dollar terms was about half of CSI 300's, according to information provider MarketWatch.

Luca Paolini, chief strategist of Pictet Asset Management, a Swiss firm, said the Chinese A-share market has been a star performer in 2020. "Among major indices, only the Nasdaq Composite Index has done better than the CSI 300. The market also showed more resilience during market turmoil."

Paolini further said the CSI 300's maximum drawdown in US dollar terms, or the biggest decline between the peak and the subsequent trough in the year, came in at 18 percent, compared with 34 percent of global equities and 30 percent of Nasdaq.

Pictet increased its multi-asset exposure to A shares last year to capitalize on China's quick containment of COVID-19, he said.

Many other global asset managers sought shelter in China as turbulence roiled global financial markets in 2020. As of Dec 24, the A-share market saw net capital inflows totaling 195.4 billion yuan ($29.9 billion) via stock connect programs with Hong Kong, according to market tracker Wind Info.

"China was the 'first in and first out' amid the pandemic. So domestic sentiment has really turned positive and global investors are pouring money into the China market," said Wang Qian, the Asia-Pacific chief economist at Vanguard Investment Strategy Group.

Looking ahead, leading global asset managers said they believe Chinese equities will continue to bring solid returns to global investors, on the back of recovering corporate earnings and the promise of breakthroughs in technological innovations like 5G, internet of things, artificial intelligence, industrial internet, robotics, automation, and big data.

China is expected to deliver strong economic growth in 2021, thanks to an expanding domestic market as well as a larger room to maneuver macroeconomic policy, said Mike Shiao, Invesco's chief investment officer for Asia excluding Japan.

The consensus forecast is 8 percent GDP growth this year on a relatively lower base of 2020 that will likely see an estimated growth of about 2 percent, against 6 percent in 2019, Shiao said.

Still, 2 percent growth in 2020 represents a solid economic recovery in China when viewed against dismal scenarios in many other comparable economies.

Resilient corporate earnings are likely to help Chinese equities outperform this year, even as technology-related tensions with the United States linger, said Kevin Anderson, head of investments for Asia-Pacific at State Street Global Advisors, the world's third-largest asset manager. It has assets worth $3.15 trillion under its management.

Admittedly, the US government's actions to block US investments in certain Chinese stocks and other sanctions against Chinese companies may affect some sectors, which investors should be "selective around", Anderson said.

In December, the US government alleged that four Chinese companies are owned or controlled by the country's military. Market mavens interpreted the move as an attempt to prevent US investors from buying shares of the four Chinese companies.

"That, in our opinion, does not dent the need or the importance for investors to focus on Chinese equities (as a whole), going forward," Anderson said.

According to him, quantitative easing that has pushed up valuation of equities thus far may provide less support this year as policymakers gradually wean economies off stimulus. This will make earnings growth the major source of market returns.

"We think China deserves to be a focus for investors for that reason," he said, adding that this is particularly true for some domestic demand-oriented consumption stocks and growth companies that drive the nation's digitalization and technological self-reliance.

The annual Central Economic Work Conference, which was held in Beijing last month, charted the course of the economy for this year. It called for efforts to strengthen China's competitiveness in strategic scientific fields and technologies, improve industry and supply chains toward a more independent and controllable position, and expand domestic demand. The three factors have been identified as key economic tasks.

This found an echo in the Fifth Plenary Session of the 19th Central Committee of the Communist Party of China, which decided that the country will uphold the central role that innovation plays in modernizing the country and turn self-reliance in science and technology into a strategic pillar for national development in the 14th Five-Year Plan period (2021-25).

China's technology sector is set to benefit from the 14th Five-Year Plan that emphasizes innovation as the core of development, playing an increasing role of import substitution through manufacturing upgrades, Paolini from Pictet said.

He also said multiple uncertainties, ranging from the possibility of the US government escalating sanctions to impact of domestic antitrust policy moves, may weigh on investor sentiment toward Chinese technology shares.

Over the medium to long term, however, a positive outlook on tech shares is intact as the country makes more efforts to sharpen its technological capability while digitalization accelerates partly due to the COVID-19 pandemic, he said.

The accelerated growth of 5G rollout, artificial intelligence, and the internet of things is going to be an important driver of new business models that will dominate people's lifestyle, Paolini said.

"On those areas, China has a natural advantage from the sheer size of its domestic market as well as the engineer dividend with 9 million new college graduates per year," he said.

As a key part of the country's efforts to promote innovation-driven growth, China has announced it will deepen capital market reform and opening-up policy to boost direct financing this year, which will further brighten investor confidence, experts said.

According to Yi Huiman, chairman of the China Securities Regulatory Commission, the top securities regulator, increasing the share of direct financing is of great significance for spurring innovation, given equity financing's feature of sharing both risks and benefits among shareholders.

In the 14th Five-Year Plan period, China will work to implement the registration-based system for stock issuance across the whole market, establish a regular delisting mechanism, and increase the proportion of direct financing, said a document released after the Fifth Plenary Session of the 19th CPC Central Committee.

For the CSRC, the top priority this year is going to be improvements to rules, in order to boost technological innovation. It said it will also strive to steadily promote high-level, two-way opening-up in markets, industries and products.

As the country steps up efforts to increase the share of direct financing, the growth of China's A-share market, which is already the world's second-largest stock market, will outpace the country's economic growth, said Wang from Vanguard.

"Further liberalization of the China market will be a win-win situation for both China and foreign investors," Wang said, adding that Chinese equity assets could offer both higher returns and diversification benefits for global investors.

The correlation between China and global markets will be positive but low in the long run as China's economic cycle has been largely driven by domestic demand, which provides critical diversification benefits to Vanguard's global portfolio, she said.

Experts, however, have also warned about downside risks to A shares this year amid protracted uncertainties. China's gradual normalization of monetary policy and a global economic recovery may weaken the advantages of Chinese equities, they said.

"Our base-case assumes a globally synchronized return to normalcy, and therefore we will likely tactically trim our overweighting in Chinese equities to gain more exposure to other parts of emerging markets and Japan," Paolini said.

Normalization in monetary policy, accompanied with tighter credit conditions, would mean the current valuation level may not be sustainable, though it will likely be offset by earnings growth driven by strength in consumption and exports, he said.

"But, overall, diversification plus the depth and the breadth of the equity and fixed-income markets would mean that global investors must look at China," said Thomas Fang, head of China global markets and QFII (qualified foreign institutional investors) representative with UBS, a multinational investment bank.

Fang said he expects global investors as a whole to continue increasing their weighting of Chinese equities and fixed-income assets in the coming two years, attracted by fast-growing industry leaders and higher yield prospects in a low-return world.