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China challenges: three tactics for surviving the storm

China challenges: three tactics for surviving the storm

The negative consensus on China was highlighted through the massive A-share market sell-off in August 2015 and the difficult start to 2016 also with the circuit-breaker mechanism being introduced and immediately suspended.

Investors agree the main reasons behind international scepticism is the slowdown in economic growth, rising debt levels, under-performing state-owned enterprises and high valuations in certain sectors of the Chinese equity market.

While this paints a particularly bleak picture for the market, how are top investors tackling these challenges? BlackRock's Andrew Swan, Ashmore’s Jan Dehn and Comgest’s David Raper believe there are still ways into the market regardless of the ongoing difficulties. Here they discuss three different tactics for tackling the turbulent market.

Hold onto H-shares

For Andrew Swan, head of Asian equities, fundamental equity division, BlackRock, the emphasis on the A-shares market, which have borne the brunt of much of the market malaise, means investors should consider returning to H-shares instead.

In the offshore equity market, we feel that the pessimism is well-priced in in the Hong Kong listed stocks. Higher volatility is expected in the near term, but with better structural improvements already put in place over the last couple of years (and further improvements may be on the way), we believe that if Chinese regulators successfully achieve a soft landing, we may see a better environment for H-shares than we have had over the past five years.

We remain constructive on H-shares where we see better relative value. We prefer accessing Chinese stocks via the offshore markets and only have very limited exposure to the A-share market (less than 0.6% in any of our funds). We stay focused on selecting stock specific exposure in both new and old economy stocks that can benefit from China’s structural reforms, but are cautious on adding exposure in what is a very volatile market.

Stick with the 'new' approach

Much has been made of the switch to a so-called 'new' economy and Comgest's David Raper believes investors should not now lose faith despite the headwinds caused by this transition.

The ‘new’ China, hosts a range of companies, for example in the internet, insurance or gaming space, with high margins, strong capital returns, cash rich balance sheets and good growth prospects.  In our view, the ‘new’ China offers valuable investment opportunities over the next stage of China’s development.

NetEase, for example, an online gaming and advertising company, is a stock we are invested in that has demonstrated sustained growth over more than a decade. It has very sound cash fundamentals and was extremely successful in shifting its gaming software franchise from desktop computers to mobile computing, which now accounts for more than 50% of its gaming revenues.

Remember the RMB

Jan Dehn, head of research at Ashmore Group, echoes Raper's commitment to the longer-term cause and says investors should not take their eyes off how the currency pans out.

China can take comfort in the fact that this is only a temporary problem. As China accelerates its liberalisation efforts and institutional participation becomes more important in all China’s markets then the current inefficiencies will gradually wane. The real risk facing China is excessive currency appreciation. QE will eventually trigger inflation and currency weakness in the countries pursuing such policies.

When this happens, the RMB will come under constant pressure to appreciate against the QE currencies. It is important that investors and the Chinese authorities alike continue to keep their eyes firmly on this particular risk. This is why China must continue to reform, even in the face of short-term speculative pressures.

China is travelling in the right direction and those investors that buy a business ticket for the whole journey are more likely to end up richly rewarded than those cling to the handrails for a short ride.

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