Tulloch braces for China slump

First State Asia Pacific Leaders manager runs chunky underweight to Chinese equities ahead of expected pull-back.

First State’s Asian fund star Angus Tulloch has warned investors need to brace themselves for falls in Chinese equities in the near term.

The manager of the £5.7bn Asia Pacific Leaders fund is keeping his direct country exposure and commodities weighting at just 6% and 5% respectively, well below the benchmark, amid concerns over headwinds facing the country’s stock market.

“When investing in EM, you should always remember you get two steps forward and one step back. Now, I would think a step back is due, especially because of China.

“The main reservation with China is the assumption the country will continue to grow indefinitely, but as the economy becomes larger, that is more difficult to achieve.”

Tulloch said the perception the Chinese government has been an efficient manager of the economy shows people overestimate its ability to manage the pace
of growth.

“People assume what has happened in the past will go ahead without bumps, and the market is surely not anticipating any sharp relapses in the growth pace, when maybe it should.”

The manager added a decline in the pace of economic growth is likely to cause a number of hurdles for investors which have not been priced in to valuations.

“If we are right about economic growth slowing down in China, the commodity story will appear much less attractive in the future, while many companies across the whole EM spectrum will take the hit,” he said.

He said the quality of Chinese companies’ governance represents another issue for those looking to invest directly in the country.

“We are favouring Taiwan and Hong Kong-listed Chinese companies because of their much purer agenda and longer track record,” he said.

“Many Chinese state-controlled companies have goals that do not match the sustainable long-term returns we look to get with our stocks.”

Tulloch also warned China’s credit backdrop is very tight, and with numerous companies investing from overseas in US dollars, it risks creating an “imbalance that could prove dangerous in the future”. 

“We are worried many Chinese companies have taken their debt overseas in US dollars, and if for any reasons the dollar was to appreciate against the currency, that may result in issues.”

Further interest rate rises could also be unsustainable for China and other Asian economies, he added:  “If people start losing confidence in the renminbi, interest rates will have to rise sharply, and we are concerned real positive interest rates will not be sustainable in the long run.”