China equity and bonds: tapping renewed potential

The potential for China equity and bonds looks promising again amid supportive growth trends driven by a loosening policy and regulatory stance that bucks the cycle in many developed markets.

Jun 30, 2022

4 minutes

Wenchang Ma
Alan Siow
The potential for China equity and bonds looks promising again amid supportive growth trends driven by a loosening policy and regulatory stance that bucks the cycle in many developed markets.

The fast view

  • Unlike in developed markets, China has scope to use monetary and fiscal tools to fuel growth
  • China’s economy is more resilient to high energy and food prices than most other countries
  • Valuations of domestic equities and bonds are low and attractive
  • Chinese securities are still under-represented in most global portfolios
  • Investors must be wary if they plan to time the market – and need instead to make selective allocations to maximise the long-term potential of China equities and bonds

Inflation, growth and policy: a three-pronged recovery path

Global investors can expect China to return to a growth trajectory as it starts to reopen, both domestically and to the world. Perhaps most notably – and in contrast to developed markets – fiscal and monetary policies are supporting a rebound.

This broad policy focus on stable growth is boosting investor sentiment – to the point where portfolio flows that have struggled amid narrowing interest rate differentials and a muted economic outlook are recovering in equities.

Inevitably, risks remain. The zero-Covid stance leaves a chance for further lockdowns. Further, weaker points of the economy like property and employment data are concerns for the authorities. Yet resilient exports, a pick-up in infrastructure investment and low core inflation relative to global levels all offer scope for optimism.

Ultimately, China’s objectives of self-sufficiency, internal reforms and economic upgrading position it relatively well for the rest of 2022, and beyond.

Taking a selective stance in China equity

Amid the various structural changes underway in China’s economy, the expected outcome is slower but more sustainable growth.

“More and more investors are thinking about China equities as an attractive long-term structural area for asset allocation,” said Wenchang Ma, Portfolio Manager of China equities at Ninety One.

For the time being, investors need to grapple with a less-than-favourable short-term outlook. At the same time, however, valuations look attractive, especially historically. Liquid, large-cap A shares, for example, are trading at a significant discount to their US peers.

Such trends create a compelling long-term case for China, where Ma points to significant potential in:

  • Technology self-sufficiency
  • Consumption growth
  • Energy transition
  • Continued reform and economic reopening

A longer-term view enables investors to look past such shorter-term disruptions. The tech sector is a case in point, believes Ma. “In the context of the history of China’s equity market, the tech sector is not the first to have experienced regulatory tightening. However, healthy growth is still something that policymakers want to encourage.”

This type of mindset is essential if investors want to readjust their portfolios from being underweight China. Resolving this under-representation by increasing allocations should create a positive knock-on effect via support for flows into Chinese equities.

Bringing onshore China bonds into portfolios

Opportunities to boost the representation of China bonds in investor portfolios are also on the horizon.

While the macro drivers of growth, inflation, balance of payments and US-China relations are mostly neutral for the fixed income universe, there is policy support to offer optimism, believes Alan Siow, Portfolio Manager of China Fixed Income at Ninety One.

This puts onshore CNY bonds in the spotlight – from the perspective of strong fundamentals, attractive valuations and solid supply/demand dynamics. At the same time, the valuations of offshore US dollar-denominated bonds should also potentially appeal to investors.

The key features of China onshore bonds that have already been attracting investors in recent years still hold true. These include the potential to boost fixed income yields and take advantage of the diverse and differentiated domestic credit markets, which provide diversification and returns, added Siow.

There are some downside risks across the China fixed income landscape. For example, lockdowns can create more disruption to supply chains and wear on confidence, leading to downgrades of growth expectations. However, compared with major global bond markets, onshore CNY bonds also offer higher real yields with historically lower currency and bond price volatility.

“The reason why investors like Chinese fixed income is that it can provide quality and diversification at an attractive yield,” explained Siow. “We expect onshore CNY China bonds to outperform global bonds over the medium term.”

Wenchang Ma
Co-Portfolio Manager, All China Equity
Alan Siow
Co-Portfolio Manager, All China Bond

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