Investor Dialogue

Investor Dialogue: Robert Horrocks

Robert Horrocks of Matthews International Capital Management talks to Nick Lord about why China should now be seen as a distinct asset class.
Robert Horrocks, Matthews International Capital Management
Robert Horrocks, Matthews International Capital Management

China’s increasingly important global economic role has not been matched by the performance of its stock markets. How should investors play the China story?
The latest headlines on investing in China essentially reflect a simple bull versus bear debate. As valuations decrease in the face of growing potential risks, the question on many global investors’ minds is: ‘Should I buy or sell China?’

But as economic realities have evolved, this binary approach is becoming outdated. I think the more relevant question is how to invest in China, not when or if. Why? Because considering China as a distinct asset class may be a more effective long-term approach to capitalising on the country’s growth, which is the main reason that investors have sought to focus on China in the first place.

HORROCKS' TOP THEMES

1
Consider China as a distinct asset class to capitalise on the country’s growth

2
Investors increasingly have access to smaller, more nimble, growing businesses in China

3
Chinese stocks offer competitive dividend yields relative to the US, Japan and Europe

So how should they invest in China as a distinct asset class?
Well, investment strategy always matters. But the choice of strategy, which seems second nature when applied to US investments, is still a new concept when applied to China. The commitment to a geographic area as a strategic and permanent part of a portfolio means that more consideration should be made to the strategy employed there. That time has now come for China, a market that offers opportunities beyond traditional growth plays, but also for those seeking income via dividends or to pursue the rapidly expanding universe of smaller companies.

Despite its size, continued growth and expanding capital markets, China has been a peripheral part of many global portfolios; it is still a leveraged play on global growth, of interest in a short-term, tactical sense.

But during periods of slowing global growth, such as now, exposure to China is reduced — if not eliminated.

The focus on China itself as the potential new engine of global growth has only made this trend more pronounced.

But with growth and prices falling is it more difficult to make the case for China as a distinct asset class at the moment?
It is evident China’s growth has moderated, and may do so further. However, these short-term challenges do not negate the compelling reasons for considering China as a separate and distinct asset class. These include: the size of its markets and economy, prospects for profitable growth and the diversity and liquidity of its markets.

China’s contribution to GDP is 9% of the world’s economic activity compared to the US at 23%. Many projections show China is likely to become a bigger part of global economic activity than the US, or the whole of Europe in the future.

Also the combined market capitalisation of China, Hong Kong and Taiwan already stands second only to the US in terms of its share of the global market.

Notably for investors, China’s equity universe is diverse. A multitude of new listings lifted the combined market capitalisation for its domestic exchanges to $3.8 trillion at the end of June 2011, up dramatically from $402 billion at the end of 2005. Hong Kong’s total stock market capitalisation grew from $1.1 trillion in 2005 to $2.6 trillion at the end of June 2011, of which mainland Chinese companies account for half.

Is it all about size of the market or the overall economy? Presumably there needs to be a mechanism for translating that into actual investment performance?
The size of an economy alone is not sufficient to declare it an asset class. Prospects for growth are key. However, headline rates of growth matter far less than the growth of profit-making opportunities. Here, China stands out. Its growth has come from increased total factor productivity, or in other words the ingenuity with which inputs of labour and capital are combined.

China’s rate of this growth, above 4%, far exceeds that of Western economies and Japan.

This quality growth has been achieved in a diverse range of industries. China now boasts not only the world’s largest automobile market but also an economy in which new consumer tastes are emerging and creating new opportunities for smaller and more nimble companies in areas such as luxury goods retail and fast food chains. For instance, with the rapid growth of personal wealth fuelling luxury consumption, one of the retail distributors in China is now the global leader among all dealers for both Rolls-Royce and Bentley.

Can institutional investors really invest in these companies?
Yes, investors increasingly have access to these businesses — the number of listed small companies, excluding A-shares, has almost doubled over the last five years. While there are inherent risks to investing in smaller companies, they also account for two-thirds of patent registration, three-quarters of technology innovation, and four-fifths of new product development and urban employment. Small-capitalisation stocks have been a primary component to China’s growth, but they often attract little attention from typical global investors.

Is it only about finding the next growth stock or are there other angles?
Investors in China, especially those just focused on short-term returns, are often oblivious to the income generated by Chinese stocks.

Dividends act as a way to extract tangible value from investments and, reinvested, account for more than two-thirds of the total returns from Chinese stocks during the past 20 years. Chinese stocks have also offered competitive dividend yields relative to the US, Japan and Europe. During times of slowing growth, these yields offer the incentive to stay invested and can potentially show less volatility than growth stocks.

China’s growth will meet periods of moderation. But this does not warrant exiting Chinese stocks entirely.

Rather, it is an opportunity to adopt strategies for better approaches to China that suit investors’ long-term goals.

 

This story first appeared in the February issue of FinanceAsia magazine, available to subscribers here

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