We’re global investors. Central to the idea of a diversified portfolio is exposure to global markets, because markets, and the assets within them, tend to balance each other out. Be it growth vs. value, or emerging vs. developed, disruptions in one sector often lead to opportunities in another. By maintaining exposure to all markets, you’re in position to realize gains when one sector overperforms, and minimize the impact of losses when its counterpart underperforms.
Our travels have taken us to China several times before. It’s is an impressive place, and among the global leaders in technology, materials, transportation, and finance. But in 2021, the Shanghai and Shenzhen markets were rocked by what seemed like sudden and extreme regulation. At the center of these regulations were some of China’s biggest companies, which had drawn the attention of the Xi administration for growing too big, too fast, and outpacing the value they returned to consumers
We’re not China experts by any means, so while we’re studying the situation and monitoring our exposure closely, we wanted to share some of the best insights we’ve found from our trusted investment managers who specialize in the region.
Here are some key points to consider which we hope will add some clarity to these recent developments.
“..the silver lining of the damage done during the quarter is that many shares in China are now priced more reasonably; a meaningful portion of the bubble we noted has been pricked. Many stocks (if not all) have valuations that at last seem to acknowledge some risk of policy intervention.” – Seafarer Capital Partners
Searfarer Capital Partners, Portfolio Review – Third Quarter, 2021
Chinese stocks collapsed in the 3rd quarter across a swath of industries following major policy interventions enacted by the Xi administration. The Seafarer team has always treaded very carefully in China, but they don’t think there is as much there there as many others suggest. China is totally investible, you just need to be selective and appreciate the sometimes not so silent partner in your holdings. One interesting side note – Seafarer characterized the policy changes by the Xi administration as less regulatory, and more targeted to the industries and companies it wanted to reign in, which resonates with a previous commentary regarding the economic impact of fiat policy decisions.
You can read Seafarer’s full commentary here.
“While we recognize that the regulatory environment has become more stringent, we have not seen evidence to suggest that China has changed such that businesses cannot operate fairly and shareholder rights are not being respected.” – Oakmark Funds
Oakmark Funds, Regulatory Changes in China and Our Approach to Risk Management
Don’t freak out over the recent regulations and policy actions enacted by the Chinese government. Many of them were reasonable, and designed to prevent the anti-trust and user data legal disputes Western technology companies are currently wading through. In fact, Oakmark suggests that policy makers in the US and other Western nations would impose similar regulations if they could. BUTTTTT the big difference, of course, is that China is a communist country, and operates by much different rules when it comes to implementing corrective government policy. But the takeaway here, is that as an outside investor, you should demand a much higher risk premium when investing in Chinese companies. While China is certainly investable, it’s not without risk, and you need to factor in a higher discount to account for it.
You can read Oakmark’s full commentary here.
“While it’s true that China’s economy is radically different from the United States, investors in both countries must grapple with the same question today—How much of today’s economy is real (durable, lasting), and how much is fantasy (and likely unsustainable)?” – Rondure Global Advisers
Rondure Global Advisers, 3Q21 Fund Commentary
While Chinese companies operate in a drastically different economic system than those domiciled in the US, investors looking at assets from either country must figure out how much hype in the markets is real, and what the true price should be. Take for instance the merging similarities of housing prices. Prices in both countries keep going up! And with additional policy changes likely, Rondure’s trust in their models for Chinese companies is at an all-time low. If structural change in underway, it makes investing much more uncertain, especially since housing speculation is up, and demand is slowing down. One study estimates that a 20% fall in Chinese real estate activity (lending, construction) would lead to a 5-10% contraction in GDP.
You can read Rondure’s full commentary here.
China is a one-government system. They move a lot faster than the US. However, when I reached out to some of the contacts I made in China, they seemed sanguine about the recent upheaval. The prevailing attitude there is, yeah those people got too powerful and needed to be checked. What’s shocking to the West is that these regulations happened at all.
And like many industries in the West, the internet in China – and China’s internet infrastructure rivals and may even be better than ours – will create new and more powerful winners. As those winners grow, they will become more closely watched. If they get so big that they start taking more from society than they give, the government will come down hard. That’s what happened with the education sector as well.
While these companies are mostly dead in the water, the rest got the message.
One thing you cannot forget is while China may have some of the best companies in the world, they still exist in China. This adds a bunch of risk, and it’s always worth remembering that their government doesn’t always act the way we in the West would expect.
If you have any questions about integrating emerging market exposure into your portfolio, schedule a meeting with one of our fiduciary advisers.