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Is China an important part of your investment portfolio?

‘We can purchase businesses in that country which trade at significant discounts to their peers elsewhere in the world, yet offer significantly better growth prospects’: Independent Securities CEO Simon Fillmore.

SIMON BROWN: I’m chatting with Simon Fillmore, CEO of Independent Securities. Simon, I appreciate the early morning time. You and your team put out a note on China. I think it was earlier this week. A really great read. You make a couple of important points. The one that really struck me – and I suppose in a sense I’d known it, but I’d never really put two and two together – is that broadly the investment world is significantly underweight China, in both equity and bonds. It’s holding about 3% whereas, considering its GDP, it should be closer to 15%. We are really significantly behind the curve.

SIMON FILLMORE: That’s quite right, Simon. Good morning and thank you for having us on the podcast. I think when we take a step back and look at China because we allocate globally, there are two major themes that are relevant to us. The one is exactly, as you touched on, that the world is significantly underweight Chinese equities and bonds. We expect that over the next five, 10, 15 years investment managers globally will allocate more capital towards China. At the moment, as you said, it’s around 3% and a more neutral weighting would be around 15%. So we think that automatically would attract inflows into China. Just the scale and size of China means that we can’t ignore it. For instance, there are more iPhones in China than there are in the US, and GM sells more cars in China than it does in the US. So China’s a significant part of the landscape. 

And within China, I think the two things that are going to drive it most dramatically over the next decade are the themes of urbanisation and consumption. So we see that there’s a significant drive to improve urbanisation in China. In China, it’s currently sitting just below 50%. The Chinese premier, Xi Jinping, has come out and said by 2035 they would like to have that at 75%, which is in line with most developed countries globally. 

As part of that cycle, as people move to urban areas and find employment, typically they become consumers in the global economy, and it’s because of that consumption by 300 million people moving to the urban areas and becoming consumers that we continue to believe that China will experience above-average rates of GDP growth over the next couple of years.

SIMON BROWN: We saw urbanisation at the beginning of this century. I was surprised that it was still only around that 50% level, and therefore literally hundreds of millions more people were moving into the cities. There’s some controversy around China, but in truth, a lot of it is perhaps frankly ill-informed. I hear all the time that Chinese banks are going to collapse, and that everything’s going to [collapse]. 

But actually, it’s a growing economy. They’ve got a high savings rate. They have a current account surplus – have had and will continue to have. This is not a sort of ‘third-world basket case economy’ by any stretch. It has a developed and efficient working banking system – in many cases probably better than many of the developed economies.

SIMON FILLMORE: Yes. I think those points you touched on there with regard to the high national savings rate, the current-account surplus – if one does extensive studies historically, with those factors present you typically haven’t seen a financial crisis that’s been led by banks. Certainly, Chinese banks do have a lot of debt, and the balance sheets may not hold up to scrutiny. But I think it needs to be borne in mind that most of those banks are state-owned and essentially it’s the state owing money to itself. So we’re not too concerned about that. 

You often see scary videos of empty Chinese cities – I’ve been seeing these for 15 years. I think the point is that you’ve got this urbanisation process that is happening, and slowly those cities will be filled up.

The point is also that you don’t need to invest in Chinese banks. There is a broad spectrum of very exciting businesses that one can invest in. That’s what excites us. I think if we look globally there are very attractive opportunities in China, and we find that we can purchase businesses in that country which trade at significant discounts to their peers elsewhere in the world, yet offer significantly better growth prospects. As investment managers we get excited by that. 

SIMON BROWN: One could go the ETF route, but there are a lot of the Chinese [businesses] listed. They are listed in mainland China, listed in Hong Kong. Heck, we’ve got Tencent exposure via the JSE. And of course they list in New York, and so on. It’s not as difficult as perhaps 20 years ago to get exposure directly into high-quality, great-valuation Chinese stocks.

SIMON FILLMORE: And I think as South African investors we have a history of investing indirectly in China, even if we are not aware of it, just because of the composition of the JSE. Obviously, the most important one would be Naspers via Tencent. And then a company like Richemont, around 40% of its sales come from Asia and that’s certainly been the growth engine for them over the last two decades. 

If we look further at the commodity producers, certainly China consumes around 65% of the world’s commodities; it doesn’t have Billiton, Kumba, Anglo. South Africans have benefited indirectly by that. But we have seen the introduction a couple of ETFs on the JSE where investors can have exposure to a broad basket of Chinese equities.

And then we can now also purchase Chinese equities directly – and there are many, many opportunities in them. It’s quite an interesting field. We are finding it’s almost like those Russian dolls, where you open one and there’s another one inside; you open that one and there’s another one. We are finding that with some of these, specifically the Chinese technology companies, they’ve taken the prodigious cash flow that they’ve generated over the last couple of years and invested in other businesses. The value of those businesses isn’t always apparent on their income statements or their balance sheets. So we are finding some very attractive opportunities in that region. 

SIMON BROWN: I like your point. Actually, we’ve got a lot more China – not just Naspers. There’s Richemont, all of those commodity stocks as well. We’ll leave it there. Simon Fillmore is CEO of Independent Securities. 

Our question today on our social media – LinkedIn, Twitter, Facebook – is chatting with Simon there. China is a huge part of the global economy and only going to get bigger. Is it an important part of your investment portfolio? How much consideration do you give it when investing? Yes, you do? Perhaps the risks concern you, or just a little bit. But of course, there we actually get it via a whole bunch of different directions. 

Simon, I appreciate the early morning, sir.

Listen to Thursday’s full MoneywebNOW podcast here.

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Or you could decide not to go that route and avoid further empowering their regime. Most don’t care as long as they can make a quick buck, but it is something that investors should consider.

The reason that investors attach such a big discount to that market is that there is no rule of law in that country. The communist party makes up law as it goes along. If they feel like grabbing all foreign owned shares they will. No way I’m investing in that pariah state – steer well clear

MSCI China / Emerging Markets ?

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