Generating alpha in China: a 4Factor perspective

The fast view

• We believe there are three reasons why capturing alpha in Chinese equities is best achieved through an active approach: market inefficiencies, diverse opportunities and mitigating ESG risks.
• We have been using the 4Factor approach, which balances traditional and behavioural analysis, for over 20 years. The process has shown to work well in inefficient markets such as China.
• Our style-agnostic, unconstrained 4Factor approach – an objective screen coupled with on-the-ground fundamental research – allows us to use our expertise to select the ‘best ideas’ from a diverse pool of opportunities.
• We believe focused fundamental research undertaken by a Mandarin-speaking local team is essential to assess ESG performance.

Why an active manager can add value in Chinese equities

Mainland Chinese equities offer a deep pool of potential alpha opportunities. We believe a holistic approach, that considers both onshore and offshore equities, offers the widest possible access to companies that stand to benefit from China’s economic growth. Due to the high proportion of retail investors, China’s equity markets can be prone to periods of euphoria and herding, creating market volatility. In our view, this environment lends itself to disciplined, bottom-up stock picking to generate smoother returns.

In this viewpoint, we explain the three key reasons why we believe using specialist active expertise is better-suited to this market than a passive (index) approach.

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Specific risks. Geographic/Sector: Investments may be primarily concentrated in specific countries, geographical regions and/or industry sectors. This may mean that the resulting value may decrease whilst portfolios more broadly invested might grow. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Derivatives: The use of derivatives is not intended to increase the overall level of risk. However, the use of derivatives may still lead to large changes in value and includes the potential for large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Concentrated portfolio: The portfolio invests in a relatively small number of individual holdings. This may mean wider fluctuations in value than more broadly invested portfolios. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.

All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results.