Large, liquid and unloved: China’s story runs deeper than trade

Most of what investors hear about China today centers on the trade conflict and technology competition with the U.S. These issues, and the headlines they generate, are unlikely to disappear anytime soon. Yet they mask some important and less-read “footnotes” about the world’s second-largest economy ― and the burgeoning opportunity in its onshore A-Share equity market.

We find China A to be rich in opportunity for a few key reasons:

1. Information abundance

China is a particular interest to systematic investors, like myself, who use data as the lifeblood for uncovering unique investment insights. In fact, we find few places as ripe for tapping new and innovative sources of information.

This is due not only to the sheer size of China’s population, but also its rapid adoption of digital technologies and willingness to share personal information. A 2018 survey by market research institute GfK found that 38% of China’s internet users said they would share personal data online. This compared to a global average of 27% and was well ahead of major developed markets such as Japan (8%), Germany (12%), the UK (16%) and the U.S. (25%).

Finding an information advantage and acting on it ahead of other investors is a key way to gain a performance edge. This has always been the case in investing, but is even more important in today’s data-intensive world where finding unique kernels of unexploited, investment-relevant info is increasingly difficult.

2. Large opportunity, lite interest

Many investors do not realize China A represents the second-largest and most liquid market in the world, just behind the U.S.

The process to include China A-Shares in major global equity indexes began last year and has provided greater international visibility for Chinese stocks. MSCI will have increased its inclusion factor of large-cap China A-Shares in its emerging markets index from 5% earlier this year to 20% by November. Yet the share of foreign investors in China A remains below 5%.

The fact that the market is not as intensively researched also suggests that active investing ideas can be more powerful and persistent than in markets where information is quickly and broadly absorbed and invested on.

The current state of play may present an interesting entry point: A-Share integration will continue for a few years. When it is done, China’s onshore (A-Share) and offshore (H-Share) markets will essentially have converged. (China H-Shares trade on the Hong Kong Stock Exchange and are already open to all investors.) This may mean there is a window of opportunity for investors to tap into A-Shares before any distinction between the two markets disappears.

3. Reforming toward a new norm

Some argue that Chinese equities failed to deliver in recent years, when the domestic economy was growing exponentially. This was the case even as corporate earnings expanded. So, they question, what may be the impetus now?

Going forward, we see the Chinese equity market benefiting as the country’s economic growth model transitions away from investment and exports in favor of domestic consumption and services. Chinese companies historically have exhausted their free cash flow to support the investment-led growth model, leaving little to distribute to shareholders. This is already starting to change, as we see evidence of a material increase in dividend payments.

We also see reform continuing, but with a broader, modernized focus. Through our text mining and data analysis work, we see indications of Chinese authorities’ increased attention on citizen-friendly tax cuts and investor priorities such as technology and environmental protection. See the chart below. Lower taxes can free up more money to support domestic consumption and overall economic growth.

icon-pointer.svgSee Jeff’s Q&A on ESG.

Bottom line

Given the size and uniqueness of the Chinese equity market, we believe it is on its way to parting from emerging markets broadly and eventually becoming an asset class on its own. The current dynamics, discussed above, suggest to us that this may be a timely moment to consider exposure to the burgeoning opportunity in China A.

Jeff Shen, PhD, is Co-CIO of Active Equities and Co-Head of Systematic Active Equity (SAE) at BlackRock. He is a regular contributor to The Blog.

Investing involves risk, including possible loss of principal.

Stock values fluctuate in price so the value of your investment can go down depending on market conditions. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 2019 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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