I took the opportunity to meet up with the highly regarded China team at First State Stewart Asia, who are now a separate unit to Stewart Investors. Their China specialist QQ is a Chinese national with excellent on-the-ground contacts in mainland China. QQ visits China frequently and stated at company meetings it was apparent that things have stabilised on the ground. Chinese company management are now more positive and the wider population has regained the confidence to spend. QQ believes the leadership in China have recognised the role of the market and will intervene less and work more as a referee and policeman. Although it will be a long-term project, the government has closed some inefficient and polluting heavy industry, such as coal mines and steel producers. Favoured industries in China include technology, services and some microbusinesses which have received tax benefits. The authorities in China will continue to tackle environmental issues in the northeast of the country by closing down heavily polluting industries.
With the economy in China stabilising, corporates are now producing better earnings numbers and the most recent producer price index numbers demonstrate that the deflationary threat in China has eased. Strong retail sales figures actually mask the fact that many consumers are now buying upgraded products with a greater focus on quality. An area the team is monitoring closely is corporate FX exposure as some Chinese businesses have borrowed in US$, which is a concern at a time of a strong US currency. Within China, leisure and travel continue to increase and there is exposure to Shanghai Airport, which is an ‘A’ share. The team are also looking at some budget hotel offerings listed on the Chinese market.
Retail sales in China continue to grow strongly, at around 10% p.a., which reflects continued growth in disposable incomes. Home appliance sales are on a recovering trend. Chinese consumers now have higher brand awareness. Wage growth in China has been strong compared to the West, with the government keen to create a more even society. The government in China expects the rich to help out more. The minimum wage in China continues to grow and within state-owned enterprises, it is the lower earners within these businesses that are doing relatively better. Whilst the pace of reform has slowed in the short term, QQ expects over the next 12 months more government documents will be published, outlining the reform programme. Some state-owned enterprises have undergone trials to see how incentives and efficiency can be improved. These are often owned by local governments and there is scope eventually for these companies to be sold on to the private market, or listed on the stock exchange.
The level of debt in China remains a concern to many, but the central government itself remains under-geared. In some cases, there is too much debt at the corporate level, but the government has actually undertaken two rounds of debt swaps with local authorities. One sector the team remain cautious on is Chinese banks, where some nonperforming loans may have to be swapped into equity.
In China today, there is an unwritten protocol that 67 is the retirement age for the leadership. As a result of this, no one over the age of 67 on the Politbureau Standing Committee has been able to be considered for re-election. This may alter in October this year, when anticorruption tsar Wang Qishan may set a precedent. QQ believes this would allow President Xi to look to serve a third term.
One new name in the portfolio is Yue Yuen Industrial, which had been sold some time ago due to the problems caused by higher labour costs. This company is now a beneficiary of the RMB depreciation and the growth globally in the sportswear market. QQ believes that China will be seen as an Asian country less negatively impacted from a stronger US currency and could be viewed as one of the more stable investment opportunities in Asia going forward.
UBS have a strongly performing China Opportunities Fund, which at present is an offshore offering domiciled in Luxembourg. This fund focuses on industry leaders within sectors considered to have strong secular growth stories. Therefore this bottom-up portfolio invests on a concentrated and selective basis and has avoided the parts of China in decline, such as companies involved in heavy industry. The lead manager Bing Shi is backed up by four China industry analysts, the regional research team and other country specialists. This fund focuses on what many people describe as the ‘New China’, in other words, the country's strategic growth industries. The fund's focus on companies exposed to the fast-growing service sector has delivered strong returns to investors, well in excess of benchmark indices. Some of the drivers of performance for the portfolio over a number of years have been Tencent, the mobile gaming business and TAL Education.
Within more traditional sectors, such as financials, insurance is a beneficiary of structural growth as the insurance penetration rate is low and the government is encouraging more of the population to take out insurance rather than rely on the state. The sector is benefitting from the growth in disposable income in the country. With the minimum wage growing strongly over the last decade, more people are able to reach the threshold of insurance affordability. Ping An has a leading franchise in the country, driven by a consistently growing agency force. In China, life insurance is typically sold by tied agents, rather than independent intermediaries. Thus direct salesforces are the growth model for insurance in China today.
The fund has benefited from holding a number of the consumer-related Internet stocks, which are often US listed ADRs. This includes names such as Tencent and Alibaba. Baidu is also a significant holding in the fund and is the dominant player in the locally paid search market. UBS believe this company has strong long-term potential from its Artificial Intelligence business. Baidu is now looking to introduce picture recognition into its search process. Increased levels of urbanisation and higher wages have assisted the extensive penetration of mobile devices in China. Thus e-commerce, mobile gaming, paid search and social networking are becoming very widely accepted across the country. Tencent is the leading social network, online gaming and web portal company and in fact over half of all mobile time in China is spent on Tencent products. The company has demonstrated a strong ability to monetise its user base. WeiChat, which is a combination of Facebook and WhatsApp, has continued to innovate and disrupt existing services.
In the consumer discretionary sector, education services business TAL Education has been a long-term holding in the fund. Chinese parents remain very willing to spend on their children's education and this company has grown significantly in the online sector, where pre recorded courses and programmes for students are available. The company also has a service where students from different areas can be taught simultaneously and interact at the same time. TAL has strong word of mouth reputation for teaching quality. Offline learning centres are present in 20 cities and the target is to expand this to over 100 cities in five years' time.
The sector mix of the fund favours areas such as consumer-related IT, urbanisation and wage increases and is focused on the move by the authorities in China to move to a more service and consumption orientated economy.
The election of Donald Trump has caused angst to investors in the ASEAN region, so as a result, I took the opportunity whilst in Hong Kong to get an update with lead manager of the Baring ASEAN Frontiers Fund, Soo-Hai Lim. At the time of the meeting, whilst new US policies had yet to be announced, there had been an impact on bond yields and currency markets, with all the Asian currencies weaker versus the US $. A further threat to the region would be more protectionism from the US. Soo-Hai recognises the main threat to Asia is higher interest rates and a stronger US currency tightening domestic liquidity conditions.
Prior to the election of Trump, the ASEAN region had been the strongest performer in Asia, recovering from the difficulties of the last few years. The largest economy in the region is Indonesia, which is domestically driven and actually doesn't have a large export sector, with the exception of commodities. This meant last year, when its currency was falling, it was unable to capitalise on an improved level of competitiveness. In 2016, there has been a strong rally in commodity prices, which has been a positive. The Indonesian stock market benefitted in 2016 from the strength of its domestic bond market and this is usually a good lead indicator for the future path of Indonesian equities. One domestically driven positive for the country is that the announced tax amnesty is expected to bring flows of money back to Indonesia which had been held overseas. A further positive is that its main exports, such as coal, palm oil and oil, have seen significant price rises over the course of the last 12 months. As a result, the trade balance and current account are in much better shape than during the Fed ‘Taper Tantrum’ of 2013. Economic growth in 2017 should benefit from the government's progress on enacting infrastructure packages.
Thailand had a major challenge in October with the passing of the king, but politics should now be calmer going forward, with the next big event the 2018 election. The military junta has put in place infrastructure works and this will benefit growth in 2017. Whilst the fourth quarter of 2016 saw some sectors suffering a slowdown due to the mourning period for the recently passed king, there should be a rebound over the next 12 months. Thailand should also benefit from better consumption as the first participants in the government subsidised car buyers scheme will see an end to their finance payments.
The Philippines had a challenging time in the fourth quarter as this market was highly rated at the time of the election of populist President Duterte. Whilst originally the markets seemed relaxed about the new president, his anti-Western and anti-American rhetoric has now alarmed investors. Some corporates have now put business expansion plans on hold. America has used the Philippines for a lot of back-office outsourcing and call centres, and this is concern to the domestic economy. The market now has seen a significant correction and if the president leaves economic policy to his cabinet technocrats, a pro-business reform agenda could attract investors back.
Whilst Malaysia is a net oil and gas exporter, the country remains mired in the 1MBD corruption issue and political uncertainty.
Looking forward into 2017, the key factor behind the future performance of the ASEAN markets will be whether a strong dollar results in domestic monetary conditions tightening, which will both hit the stock market through tighter liquidity and real economic activity. Longer term, this region continues to have strong catch-up potential with the rest of Asia due to its more positive demographics and the fund remains focused on capitalising on the growing middle class in the region.
I also met up with a longstanding contact of mine at Aberdeen Asset Management, Nicholas Yeo, who is head of Greater China Equities at the firm. As an investment business, Aberdeen have become a lot more focused on China in recent years as they now have a 100% wholly owned entity in China, which will be able to sell investment products to locals.
Aberdeen have become more positive on China seeing an improvement in the domestic consumption story, which they believe will stay strong over the longer term. Looking at car sales, it can be seen why car dealerships in China are booming. The head of a dealership in China can often make US $300K p.a. and the money made in the sector is often flowing into property. Nicholas has also visited Shanghai recently, where consumption is showing the green shoots of recovery. More Chinese are now travelling to Hong Kong again to spend.
Aberdeen find some companies hard to invest in, in terms of quality, despite a strong thematic backdrop. Thus whilst demand for private medical services in China is strong, there are few investment opportunities in the sector as yet. The quality of medical services in China is mixed, as doctors are viewed as civil servants doing their duty in China, so are not paid well.
Growth in travel remains a big story in China and Aberdeen's China funds hold names such as Shanghai Airport, together with a duty-free company based in Hainan Island, which is an offshore duty-free tropical holiday resort. For those in the northeast of the country, they can go to the island in the winter and get both warmer weather and cheaper shopping! The Chinese are also travelling to their own domestic holiday assets, such as the mountainous areas. It is obvious visiting the island of Tasmania how the Chinese are now favouring holidays to regions with outstanding natural heritage rather than luxury goods shopping. Aberdeen also view areas such as wealth management and life assurance as having strong growth potential over the longer term in the country. Aberdeen have also noted the Chinese are becoming more concerned about the quality of products, and food production is an area where imports from high quality markets such as Australia, the US and Europe are favoured. Education continues to have strong growth prospects and Chinese tiger mums are well known for pushing their children hard. The Chinese want their children to go to top universities abroad and parents are very willing to pay for private tutoring.
The Chinese consumption story is being played in a number of ways, such as holding Korean cosmetic businesses, for example, Amore Pacific, which not only sells to tourists visiting Korea, but also into China through its E-retail channel. Korean culture and pop has taken a life of its own in China and Korean products, whilst not as expensive as European or Japanese imports, are viewed as better quality than domestic products.
Aberdeen believe that whilst parts of China are slowing, there remain pockets of interesting growth. Consumers do seem to be more prepared to spend, and the housing market has seen a recovery of significance in Tier 1 cities. Whilst the reform process has slowed in the short term, Aberdeen believe that the strategy of President Xi has been to consolidate power and he will then let market forces take over in time. Although there is a lot of publicity on debt levels in China, Aberdeen do not expect a crisis. Much of the lending is to SOEs by SOE banks and so is in effect sovereign risk. Aberdeen believe China remains strong enough to recapitalise its banks. In conclusion, Aberdeen believe the Chinese economy has undoubtedly stabilised and the consumer story remains strong.