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Capitalising on the stupendously Chinese ‘nation’

Much innovation and tech-related manufacturing takes place in this super-region.

On a long-haul daytime return flight back to South Africa, I watched Crazy Rich Asians – an amusing yet thoughtful film. The film is based on a fictional book of the same name written by Kevin Kwan and delves into the lifestyles of the uber rich Chinese segment of the Singapore population.

An opening quote in the book, attributed to 14th century Moroccan explorer Ibn Battuta, says “Nowhere in the world are there to be found people richer than the Chinese”. Who were the Chinese of the 14th century? Today’s China as we know it? I would argue (ignoring the politics for the moment) that the Chinese ‘nation’ then and now constitutes Mainland China, Hong Kong, Macau, Taiwan and most of Singapore. Financially speaking, is the Chinese nation an unavoidable inclusion in discretionary investment portfolios and does it offer compelling investment opportunities?

The Chinese nation has always been a behemoth. More than 1.5 billion people occupy an area that is the second largest in the world and it also has the most neighbours (>15) of any other nation in the world. No matter where you are in the world, most of the stuff you wear and use has been manufactured in one of the Chinese ‘nations’. Economically speaking, as the graph below shows, the Chinese ‘nation’ has a share of GDP in USD on a PPP (general prices of common goods are the same in any nation) of more than a fifth. Trend-wise it has had the sharpest slope of rising share of world GDP.

I would argue that another key economic metric to consider is the size of foreign exchange reserves. The Chinese ‘nation’ holds about $4.5 trillion, more than 3.5 times the reserves held by Japan in second position. Globally, investment returns are predominantly driven by liquidity, sentiment and valuations. Rising GDP should positively influence all three drivers to some extent. The presence of huge foreign exchange reserves lends support (both defensive and growth) to the markets in the countries within the Chinese ‘nation’.

Most South African investors have exposure to China. Predominantly this is via Naspers in their retirement funds. The biggest driver of Naspers’s valuation is Tencent, the Chinese internet and gaming company. Naspers accounts for about 20% of the JSE’s value. Indirect exposure to the Chinese ‘nation’ is also achieved via exposure to mining stocks, given that most of our minerals are exported there. Is the exposure to Tencent/Naspers and mining stocks sufficiently diversified?

The economies that comprise the Chinese ‘nation’ are quite diversified. Hong Kong, Singapore, Macau and Taiwan, have very consumer driven societies given the relatively higher disposable incomes of their residents. Mainland China still has significant numbers of relatively poor people and therefore drivers of economic activity are developmental in nature. Key sectors are manufacturing, agriculture and services. Combined as a Chinese ‘nation’, one gets the sense that there are sizeable diversified opportunities to for an investment portfolio. The key thing about the Chinese ‘nation’ markets is their high intra-regional trade and informal business networks maintained for millenia.

For purposes of illustration, some portfolios are presented below that focus on the Chinese ‘nation’. Portfolio 1 is a combination of actively managed funds. Portfolios 2 and 3 are combinations of regional ETFs from iShares. The asset mix in Portfolio 2, is based on the GDP PPP sizes of each market. The benchmark is iShares Core Emerging Markets ETF.

The table below shows the various sectoral exposures of the three portfolios.

Category

Portfolio 1

Portfolio 2

Portfolio 3

Basic Materials

2.66%

2.79%

3.37%

Consumer Cyclical

14.49%

19.79%

10.95%

Financial Services

21.34%

24.64%

31.37%

Real Estate

6.22%

6.41%

11.34%

Consumer Defensive

7.89%

3.80%

3.46%

Healthcare

3.15%

2.45%

0.95%

Utilities

1.80%

2.40%

3.01%

Communication Services

3.98%

5.21%

4.11%

Energy

3.18%

3.95%

1.31%

Industrials

8.45%

6.23%

10.49%

Technology

26.84%

22.32%

19.64%

Sourced from Silicon Cloud Technologies

Some interesting observations can be made. The biggest sectors across all three portfolios are consumer, financial services and technology. After the US market, it is the Chinese ‘nation’ markets that are the other centres of the technology universe. A lot of innovation and tech related manufacturing takes place in this super-region. Financial services are a tremendous growth area as Chinese ‘nation’ citizens become wealthier and their financial needs become more sophisticated. As more and more of the world trade shifts east, gross financial flows and the need for credit creates super-sized banks. While agriculture is a major economic sector and Mainland China is one of the largest producers of grains and seeds, it is still driven by small scale farmer and not formally organized. Consequently, it is not a key traded sector in terms of equity markets.

Within the emerging markets universe, Chinese ‘nation’ markets have done relatively better in the last 6 years. However, 2018 was a rough year for the Mainland China and Hong Kong markets. In Q1 2019, the recovery has been solid. There are about 9000 listed counters on the various Chinese ‘nation’ stock markets. Contrast that with South Africa which has about 440 listed counters. Due to the higher proportion of retail investors, most of whom favour speculation, the Chinese markets are very volatile. The private DIY investor is probably better off obtaining exposure via ETFs or via a good Chinese ‘nation’ mutual fund. Exposure to the Chinese ‘nation’ in your investment portfolios is probably going to add a lot of value over time.

Pragnesh Desai is CEO of Galileo Asset Managers

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Refreshing to read something that has nothing to do with the failing ZA state. Agree with the investment thesis. In terms of valuation (P/E, PB) also compelling.

Such admiration for a communist regime devoid of human rights?

End of comments.

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