Positioning for China’s Reopening
We surveyed our Investment Team and gathered their insights into what investors need to know about the reopening of the world’s second-largest economy. Comments below are as of Feb 3, 2023.Subscribe
Michael Oh, CFA
Asia Innovators, Asia Innovators Active ETF
1. What are you considering (for your fund) with China’s post-pandemic reopening?
Asia Innovators is well-positioned to benefit from China’s reopening. There are a lot of consumer savings that have built up during the pandemic in China and with the zero-COVID policy going away, we’re looking forward to consumers spending again. I think this, coupled with an all-time-low valuations, means that China is potentially positioned to perform well this year.
Almost every growth company in China currently looks cheap to me – online platform companies, any internet company that depends on advertising spending. I think growth companies generally should perform well this year.
2. Have you made changes to your portfolio anticipating the reopening?
Innovators has positioned the portfolio for the reopening; there is a lot of pent-up demand in travel and general consumption in China, which I think will drive the economy this year.
We’ve built an overweight position in China at the expense of India. We’ve added more to internet names such as Alibaba and Tencent, also to travel-related names; Trip.com and Huazhu, and other consumer-related companies such as KE Holdings and Kanzhun. We also expect a recovery in online ad spending which was depressed during zero-COVID. As a result, we have reintroduced Bilibili into the portfolio. I think that Tencent should benefit from this online ad recovery as well.
3. Anything else Investors should know?
We now see two tailwinds in Asia, 1) China’s reopening and 2) close to all-time-low valuation. I’m bullish on Asia this year because of these factors and positioned the portfolio accordingly. We’re overweight positions in China, consumer, and DRAM (dynamic random-access memory) semiconductor names (SK Hynix and Samsung combined).
Despite the market rebounding over the past few months, I believe that it’s still not too late to jump in since most investors are still cautious. I believe that there is a very low chance that the Chinese government will backtrack from here – the power transfer is done and now it is time to create jobs and growth. Investors can finally focus on fundamentals again.
Innovators’ mutual fund long-term performance (3/5/10 years) is top-tier, not only in the Asia ex-Japan universe, but in the emerging market universe as well. I believe that Innovators should be considered a core growth holding for investors looking for emerging markets exposure. Asia is around 80% of EM today so I think investors could consider Innovators your go-to EM growth strategy.
Andrew Mattock, CFA
China Fund, China Active ETF
Most sectors of the Chinese markets were impacted by the lockdowns. On top of COVID, China was dealing with other issues such as regulatory reform, real estate, geo-politics and internal politics. All of these pressures accelerated the decline of China’s markets and almost every sector realized steep declines, except energy. In our view, we thought these pressures were overdramatized and were exacerbated by an economy already weakened by COVID lockdowns.
We’ve experienced these markets many times and took this opportunity to buy into well-run companies at what we think were advantageous prices. So, we’ve actively positioned our funds in these exact same areas that experienced steep declines.
Some of these sectors have already seen a rebound: real estate is up 136%, communications services is up 123%, but we believe that many companies are still underpriced in these markets- the MSCI China Index is priced at the same value as 2007.1
China’s valuation is now comparable to the Great Financial Crisis- so over the past months, we focused on finding quality companies that are positioned for growth. The quality of companies that we’ve bought is – we think – quite high, much higher than during the financial crisis, during that time, these companies didn’t decline as much relatively as they did recently.
Some of the companies we’ve added to are CIFI Holdings (real estate) Country Garden Services and KE Holdings, and also well-known platform companies Meituan, JD, and Pinduoduo.
We’ve taken a few positions in ‘reopening plays’ as well: Shanghai International Airport, H World Group hotels and consumer-recovery holdings such as advertising-focused media, and Man Wah furniture.
I agree with Michael- there is still room to run in China’s markets, we think we’re positioned to capture this growth. Many investors have emerging markets exposure that’s a bit light in China, especially A-shares, which is the second largest market in the world. As active managers, we’re able to ‘go anywhere’ to capture quality companies at attractive valuations, and these companies are often missing from index-based exposure. I think supplementing a core EM exposure with Matthews China Fund positions investors well to capture the potential of China’s growth as it reopens.
China Small Companies
Regaining economic mobility has large implications for the country. We expect fewer issues with businesses’ operational disruptions given that COVID lockdowns are likely behind us. We expect that there are opportunities with direct reopening beneficiaries and also in many parts of the overall economy.
The Hong Kong market has already ‘baked in’ much of the COVID recovery opportunity, but the A-share market less so given conditions on the ground remain bumpy in the early recovery months. However, the A-share market is broadly seeing similar recovery benefits and more attractive valuations at this juncture, which could serve as catalyst for its recovery this year.
We’ve added to Macau casino operator, Melco, in recent months. Macau and gaming revenues are set to recover this year as restrictions to visit this gaming destination is likely to ease further this year. All of the operators’ gaming licenses were also renewed at the end of 2022 for another 10 years, removing concerns surrounding business continuity.2
Beyond the obvious recovery that we might expect with increased tourism and better sales at restaurants, we believe that many sectors in China generally benefit from the reopening opportunity given better mobility across the country.
For example, healthcare is an area which might benefit from reopening trends. Patient visitation had been suppressed in the past as non-serious illnesses were delayed. However, we expect patient volumes to improve this year. Additionally, healthcare stocks in general have experienced sharp corrections owing to government efforts to make healthcare more affordable by clamping down on prices. Pricing pressure has gradually subsided over the past year since some of the more major cuts have already been put in place. Valuations also look attractive and coupled with renewed catalysts of more moderate price cuts and patient traffic recovery, the healthcare sector looks interesting in our view.
Sherwood Zhang, CFA
The issues in the sectors that Andrew mentions: real estate-related, IT and platform companies, were troubling to foreign investors, but domestic investors weren’t as concerned. Zero-COVID policies exacerbated these concerns and exaggerated the slide of these stocks, in my opinion.
I took advantage during this time to reposition into some of these companies that were hurt by regulatory concerns. I manage China Dividend, and while some of these companies don’t pay dividends, our flexible approach allows us to invest a portion in growth stocks. I thought that platform companies were too cheap to ignore-and they are pursuing aggressive stock buyback plans, so these have been attractive buys for us.
In my opinion, valuations are still extremely low after these past few years’ selloff and the market wasn’t at a rich valuation even before the pandemic. So, I don’t think this is a ‘rebound play’ and it’s over, I think the environment is right for China to grow for a long time. We believe the long-term China growth story is still very compelling, as backed by the earnings-per-share (EPS) trends.
Earnings per share never went below zero and were essentially flat for the three years, so we think that EPS will be ready to grow again.3 We think this is a positive environment for investors.
China’s reopening is exciting, but investors must remember that investing in Chinese equities comes with great volatility, whether it is upside excitement or downside surprise. China Dividend’s goal is to deliver more upside than downside participation, thus we believe that investors may experience lower volatility while not giving up too much on long-term returns through a full market cycle.
Asia Growth has been quietly bullish since June 2022 by adding to the “reopening” play in travel-related holdings. We also added to the existing e-commerce and internet names, which we think are inexpensive, to position for a gradual economic recovery in China. China’s weighting in the Asia Growth Fund grew to over 40% by the end of January 2023 compared to 25% in Q3 2022. In the meantime, our allocation to India companies was down to 7% at the end of January 2023 compared to 24% at the end of September 2022. I remain bullish on China in the near-term but my outlook is cautious for the midterm.
Sharat Shroff, CFA
Since November last year, the constraints on mobility in China have been steadily removed and the economy is rapidly returning to the levels of activity that were established prior to the onset of the pandemic. Post the reopening, consumer behavior in China may be similar to the experience in other parts of Asia, but there are also likely to be some important differences. For instance, the disparity between a recovery in services and good consumption may not be as stark as in other geographies because the quantum of the COVID stimulus wasn’t as large as elsewhere. The Tiger strategy is positioned to participate in a broad economic recovery but also geared towards structural growth opportunities (like liberalization of capital markets, aspirational spending by the consumer, improving quality of industrial complex, just to name a few) that are likely to persist for the next few years.
John Paul Lech
Emerging Markets Equity, Emerging Markets Equity Active ETF, Emerging Markets ex China Active ETF
China represented a counterweight to inflation that was occurring in most other markets. I believe that improved mobility is constructive for energy demand given China’s role as a large importing market. As fundamental, long-term, bottom-up investors, we were always of the conviction that the pandemic was a temporary phenomenon albeit one of unpredictable duration. We were fortunate to not have dramatically cut companies that required mobility and close contact like hotels and restaurants. These obvious reopening plays have now run, as the markets quickly incorporated potential demand rebound into prices on offer. Investors should be optimistic about fundamentals improving, but stock prices have a habit of anticipating that improvement. Chasing typically doesn’t work well, and we anticipate that less-direct beneficiaries may have more room to run over the next few quarters. China’s reopening may benefit things as diverse as sales of life insurance policies and elective surgeries in addition to travel, services, and commodities. Optimism needs to be balanced against momentum chasing.
As of January 31, 2023, accounts managed by Matthews Asia portfolios held positions in Alibaba, Tencent, Trip.com, Huazhu, KE Holdings, Kanzhun, Bilibili, SK Hynix, Samsung, CIFI Holdings, Country Garden Services, KE Holdings, Meituan, JD, Pinduoduo, Shanghai International Airport, Man Wah. As of December 31, 2022, accounts managed by Matthews Asia portfolios held positions in H World, and Melco. This information is presented solely for illustrative purposes and is not representative of the results of any particular security or product.
Real estate is represented by the MSCI China Real Estate Index, designed to capture the large and mid-cap segments of the China equity markets.
Communications Services is represented by the MSCI China Communications Services Index, designed to capture the large and mid-cap segments of the securities in the MSCI China index that are classified as Communications Services sector.
The MSCI China Index (MSCN) captures large and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (ADRs). The index covers about 85% of this China equity universe.
1 Source: Matthews Asia, Bloomberg
2 WSJ: https://www.wsj.com/articles/six-macau-casino-operators-win-new-10-year-licenses-11669435018, Nov 26, 2022
3 Source: Matthews Asia, Bloomberg