HUB EXCLUSIVES PANEL DISCUSSION
Panel discussion, hosted by Cherry Reynard, with:
Dale Nicholls, Portfolio Manager, Fidelity China Special Situations PLC, Fidelity International
Qian Zhang, Investment Specialist, Emerging Market Equities, Baillie Gifford
It isn’t that long ago that some investment banks were dismissing China as ‘uninvestable’. Government interference in the technology sector had spooked investors, along with the US’s attempts to cut China out of key supply chains. However, it is now the US interfering in the running of its companies, while China has set out its stall as a reliable partner to business.
In a meeting on 21 March, Premier Li Qiang told a group of 70+ global chief executives including Apple’s Tim Cook and HSBC’s Georges Elhedery that China was committed to being a “cornerstone of certainty” and a “harbour of stability” at a time when the US was increasing trade protectionism and upending the rules-based order.
Should this change investors’ view of the risks inherent in China? Qian Zhang, investment specialist on the emerging markets client team at Baillie Gifford says: “Geopolitical risk is not going away, but it's perhaps more openly discussed and perhaps better understood by the market.”
She believes it is important to put geopolitics in context and that it may have been overplayed by investors looking at the Chinese market: “We are thinking about what really matters for Chinese businesses. We have talked quite a lot over the past year about the tariff war, but if you look at China's annual domestic retail sales, it is more than 10 times bigger than the amount China exports to the US. It is the domestic activities and domestic policies that - most of the time - really matter for Chinese businesses.”
“If you aggregate the revenues within MSCI China, the US exposure is still around the 5% level. Yet the trade issue gets a lot more coverage.” In terms of exports, there's a clear movement against up the value chain with the value of low value exports declining as a percentage of the total.
There are also areas where geopolitical tensions can drive opportunities as well as risks, Zhang says: “Because of the tension between US and China, and because of the Chips Act rules for China's domestic chip designers, the country is very, very keen to have greater self-sufficiency in this new technology. For us as stock pickers in China, that creates a lot of opportunities as well.”
Dale Nicholls, manager of Fidelity China Special Situations plc, says that it is not necessarily a question that Chinese risks have fallen, but that the risks elsewhere have risen. He says: “China has become more predictable in its policymaking, with the 15th five year plan. Over time, is has pretty good track record of hitting its targets and objectives, so investors can have a good sense of the general direction of policy. On a relative basis, you could question how that policy framework looks versus other countries.”
Equally, in China, geopolitical risks are priced into valuations, which isn’t necessarily true for the US. Nicholls adds: “China has traded a significant discount to many other markets for many years. We believe that could start to be factored into relative valuations given the certainty around policy compared to many other countries.”
Energy
There is a question over the extent to which China is exposed over the Iran crisis. On the one hand, China has historically received a lot of oil from Iran, taking around 5.4m barrels per day from the Middle East. There remains a school of thought that the US launched these attacks specifically to target China and undoubtedly, it is vulnerable to a prolonged rise in fossil fuel prices.
However, it has also spent huge sums on renewables with the aim of reducing its dependency on energy imports – around 3x more than the US or Europe. It also had significant oil reserves. Zhang says: “The energy density per capita is going to continue to increase so there are bigger and bigger demands, just as an outcome of the general development story. That said, China has done a great job in lifting up the new energy sector, which provides fantastic opportunities in the companies who can either participate in or contribute to that very great shift.”
The key is to be selective because there are pockets of over-supply. The Baillie Gifford team is finding opportunities in electric vehicles, batteries, solar and also niche supply chain groups, while avoiding those companies in segments with lower barriers to entry and more accumulated capacity.
Nicholls adds: “There is clearly still a risk on the level of oil prices and where they'll be in the short term, but looking out further as well. China has done a great job of diversifying their energy mix over time, but it's still vulnerable.” Zhang believes that a long period of disruption could hurt the domestic economy. “It will perhaps delay some of the domestic push of domestic reform that China is needed to solve some of its structural problems.”
However, China has proved itself relatively immune to geopolitical shocks – from tariffs to the oil price. This is no accident, with the government seeking explicitly to increase the country’s self-reliance. Equally, for many Chinese companies, the domestic environment is far more important than the international one. The geopolitical risk premium for China is already falling, and could fall further if it continues to look like the grown up alternative to the US.
