Time in the market

Investing in China – Risk & Opportunities

When investing your money, it’s important to be diversified across asset classes, factors (see here for a recent blog post explaining this), business sectors and regions. In this blog, we take a look at the Chinese market, highlighting 5 risks and opportunities that need to be considered when investing here.

Background 

Since 1978 China has averaged 10% annual growth in their GDP, placing them second in the world with GDP of $12.23 Trillion behind the US with $19.48 Trillion.

So, what are the reasons for this impressive growth?

  • Urbanisation

Over the last 5 decades, economic reform has changed China from a highly rural country to urban – many predict that this will continue for the next 20 years. There is a certain ‘snowball’ effect when a country goes from rural to urban. Cities need to be built, which requires rapid growth in infrastructure, commerce, and other services. This rapid growth requires more education, more education generally means people become wealthier and a wealthier society means more businesses are set up thus leading to even more wealth.

  • Rapid Productivity Growth

China is considered as the ‘worlds manufacturer’, but it wasn’t always this way. The reallocation of resources to more productive uses, especially in sectors heavily controlled by central governments, such as Farming, has boosted efficiency across the board. Looking at farming as an example; Investment into agriculture by the State has boosted efficiency which has freed workers to pursue new opportunities in other sectors. This decentralisation of the economy led to a huge increase in new private firms who were more market orientated and a larger share of the economy was exposed to competitive forces.

  • Capital Investment

Foreign direct investment into China led to new technology which further boosted productivity.

Risks

As with any investment, there are specific risks associated with investing in China. Some of these are as follows:

  1. Slowing of GDP Growth

Can the 10% average annual GDP growth continue? Many sceptics do not believe so – especially if its State driven. Coupled with this, if the powers that be continue to impose restrictions on foreign firms this will reduce the likelihood of this continue growth further. Foreign enterprise accounts for a significant share of China’s output but this is falling – 2.3% in 1990, 35.9% in 2003 and most recently 25.9%.

  1. Geo-political Relations

China may align itself further with Russia and become less dependent on the US. We could even see an emboldened attack on Taiwan which could lead to similar sanctions we have seen placed on Russia.

  1. Ageing Demographic

In 1980 China’s population was rapidly expanding and the government launched its ‘one-child’ policy which ended in 2016. This policy has led to a rapidly aging society and by 2035 more than 30% of its population with be over 60. This has led to a declining workforce and a need for an increase in spending on healthcare and elderly services meaning less resources for elsewhere.

  1. Zero Covid Policy

China is still implementing a zero Covid policy – an outbreak of cases results in whole cities being sent into lockdown which slows the economy. An outbreak in Shanghai could result in the port being shutdown which would not only slow China’s economy but the world’s, given that China is the ‘worlds manufacturer’.

  1. Government Corruption

There is a view that alleged corruption can play a major part in success/failure rather than market forces. As well as this, due to the court system in China, intellectual property rights can be hard to protect and enforce.

Opportunities

China is c.20% of the world’s population so is it too big to ignore? Below are 5 points which may suggest there is an opportunity for investing in China.

  1. GDP Growth

I have highlighted GDP as both a risk and opportunity… China is restructuring its economic model after a successful period of going for growth. The new model aims for sustained growth with an emphasis on innovation as the new driver. The new focus will provide a lot of opportunities for new businesses to grow and flourish.

  1. Less Bureaucracy

The government is aiming for China to be the number one economy in the world and will use all its power to help it achieve this. If they want to bring in a policy to help them achieve this, less bureaucracy within their system will mean they can.

  1. Geo-political Relations

China is currently benefitting from cheap fuel from Russia. We have all seen the impact of extortionate fuel prices in the UK so nothing further needs to be said!

  1. Low Inflation

Coupled with the cheap fuel from Russia, China didn’t offer much financial stimulus during Covid which is helping to keep inflation down. As well as this, they produce a lot of their own resource in country so are being less impacted by global inflation.

  1. Valuations

Chinese stocks are on affordable valuations at 8x price to earnings ratio whilst the UK is 14x and the US is 19.5x. This means that Chinese equities are at a discount compared other markets.

Summary

To summarise, as with any market, there are risks and opportunities with investing in China and it’s our job to assess your circumstances and conclude if an allocation to China is suitable for you. Generally, China would be more suited to high-risk clients with a long timeframe for investing but some exposure can be achieved for lower-risk clients through an Asian fund.

As always, if this blog has raised any questions, please get in contact with your adviser.

The content of this newsletter is for your general information purposes only and does not constitute investment advice. It is not an offer to purchase or sell any particular asset and it does not contain all of the information which an investor may require in order to make an investment decision. Please obtain professional advice before entering into any new arrangement. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles. 

Your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

 

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February 20, 2023 Post by Stephen Jordan
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