Quality investing

China's self-sufficiency opportunity

The past couple of years have been disorderly for Chinese equities. However, President Xi’s recent reshuffle provides greater clarity regarding the government’s direction of travel. In our view, the trend towards localisation – prioritising domestic champions over foreign alternatives, in order to drive self-sufficiency – will benefit several leading companies within the quality spectrum, particularly in the software, healthcare and consumer sectors.

11 Apr 2023

27 minutes

Podcast: Quality in China

In the second edition of our Quality podcast, the team looks at investment in China, and why - irrespective of ongoing tensions with the US - there are rising opportunities for quality businesses within the country.

China’s equity market has had a tumultuous couple of years, against a backdrop of heightened tensions with the US and COVID-related supply chain troubles. The Hang Seng Index halved from February 2021 through October last year as sentiment reached a nadir. The market then soared by 50% through January as the relaxation of stringent measures around movement were lifted, with expectations that China’s deep savings pool – amongst the highest in the world1 – would be put to work.

Most recently, we have been in somewhat of a holding pattern, as investors digested the results of the annual nine-day gathering of the National People’s Congress, China’s legislative body. Xi Jinping was confirmed as president for a precedent-breaking third term and installed many of his allies in top government roles. Importantly, new Premier Li Qiang sought to reassure the country's private sector and outlined policy will focus on domestic growth and high quality development.

Self-sufficiency aligns with a quality approach

From an investment perspective, the focus on science, healthcare and technology is especially encouraging, with these disciplines aligning with our Quality team’s approach to equity investing. At a time when relations with the US are expected to remain fraught for the long term, we believe it would be prudent to invest in pockets of the market likely to benefit from policy tailwinds. Beijing’s drive towards self-sufficiency – ensuring that products are made or innovated in China – will inevitably impact a number of local companies.

In IT software, for instance, Kingsoft2 – China’s version of Microsoft – has a compelling growth runway as the government shifts users onto the company’s software, and away from early versions of Microsoft’s platform. Another local champion is Glodon, whose software improves the safety, quality, efficiency and profitability of China’s property industry. Given that markets typically operates on low profit margins of around 3%, demand for Glodon’s software which can add cost saving to the industry, has been strong, evidenced by its 20% annual revenue growth over the past five years.

Healthcare goals to benefit dominant leaders

The same rationale applies to the healthcare sector, with Beijing striving to become more self-sufficient in cutting edge technology such as medical devices. This would help from a national security perspective should the US ever consider export bans on medical devices, and to help continue to protect its citizens. Beijing has already doubled the number of intensive care beds per 100,000 people following COVID to 10, but this falls someway short of the 25-30 available in Europe or the US. It’s serious about catching up, whether in ICU, surgical rooms or everyday diagnostic functions. Medical device producer Mindray is the dominant leader with best-in-class products, technology, reputation and cost control, so it has an almost impregnable position in a structurally growing market fully backed by the government.

Further examples are plentiful. Healthcare requires research to move forward, and in Tigermed, China already possesses one of the most prominent contract research organisations in the world. In the consumer space, staples such as Fuling Zhacai and liquour producer Kweichow Moutai are in positions of strength heading into a period of extended growth. So, while China’s trend towards localisation might intuitively sound introverted, we believe the opposite could be true. An uplift in local expertise could help the country further entrench its position as an indispensable link in the global economy, with a number of quality sectors being notable beneficiaries.

1 Source: World Bank. China is ranked 4th with a rate of 44.89% of GDP. The average for 2021 based on 132 countries was 23.47%.
2 This is not a buy, sell or hold recommendation for any particular security.

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