China's effective handling of the Covid-19 crisis has arguably brought about a positive shift in investors' perceptions about Asia's largest country. More investors have started to look at China as it is rapidly becoming an engine for global growth.
China looks increasingly attractive for investors seeking an economic return despite a lot of misconceptions about Chinese companies and a tailing strong bias against them.
The country has not significantly expanded its balance sheet during the crisis, has sensible interest rates and decent growth - in contrast to developed markets, whose further leveraged balance sheets mean they are likely to keep zero to negative rates for many years and offer very little growth.
Manufacturing activity in China largely recovered throughout the summer, most offices in Shanghai are fully open and operational face-to-face business meetings with companies and clients are back.
Having handled the lockdowns well, China is the only large world economy expected to grow in 2020 (at 1.9%, according to IMF at 13 October 2020) and accelerate further to 8.2% in 2021.
This compares to the advanced economies' contraction of 5.8% in 2020 and the return to growth at 3.9% in 2021.
The country continues to face risks. These include trade tensions with the US, weak overseas demand, an increase in the volume of bad debts held by Chinese banks, poor disclosure on the corporate side, weak internal consumer demand for services and inferior corporate standards from an environmental, social and governance (ESG) perspective.
Nevertheless, China's unsurpassed economic success of the past 40 years has created compelling investment opportunities. China has proven its ability to deliver world-leading companies through investment, innovation and support.
The shift between the 'old' and 'new' economy sectors continues, as rapidly growing e-commerce, online payments, renewable energy and healthcare industries begin to dominate more traditional stalwarts of the Chinese economy, such as construction and manufacturing.
The country's middle class has become the largest in the world, and its economy and domestic stockmarket are the world's second largest.
Yet China's proportion of the global stockmarket and global portfolio allocations is tiny and likely to grow from the very low base.
As at June 2019, China accounted for 18% of global market capitalisations in MSCI investable indices, 19% of global purchasing power by GDP and 31% of all global listed stocks in MSCI investable indices, yet on average only accounted for a 2.5% allocation in global portfolios.
This creates ample opportunities for global investors to allocate capital to Chinese equities.
The Chinese market looks attractive on a valuation basis. The chart on the left illustrates higher profitability of Chinese companies, measured by return on equity of 15% versus the world of 11% and it remains less expensive than the world on a P/B basis (1.65x versus 1.8x), potentially creating a valuation opportunity.
Baillie Gifford, who recently launched a closed-ended China growth equities fund, to run alongside their open-ended mandate, believe that 'still misunderstood and underinvested' China is the key global growth market of the 21st century and that global investors who miss out on the present China opportunity run the major risk of being left behind.
While there are a few dozen open-ended China equity mandates in the UK market, only three closed-ended funds offer UK investors exposure to China (Baillie Gifford China Growth Trust (BGCG), Fidelity China Special Situations trust (FCSS,) and JPMorgan China Growth & Income (JCGI)).
The latter two posted around double the performance of the Asia Pacific closed-ended sector average, which returned 141% over ten years, outperforming by 130% and 150% respectively on the NAV basis.
BGCG emerged after the board decided to switch from Witan Pacific's diversified multi-manager Asia approach to a focused China equities strategy.
The BG open-ended China strategy and Witan Pacific NAV returned 239% and 98% respectively over the past decade to the end of September 2020.
Baillie Gifford believes that picking emerging markets' outperforming stocks heavily depends on the country and geographic market of their businesses, and China is currently its top country choice. With just two other pure China equity closed-ended peers on the UK market currently, BGCG is a timely growth equity strategy offering from Baillie Gifford.
FCSS's fund manager Dale Nicholls also believes China will be difficult to ignore. He said: "The sheer breadth and depth of China's onshore markets and the lack of institutional investors means that stocks are relatively under-researched and provide rich stockpicking opportunities for active investors."
Defending the small-to-mid-cap tilt of the fund, Nicholls remains convinced that "as long as these companies execute and deliver on their strategies and earnings over the medium term, this should be reflected in stock prices over time".
He also makes long-term capital growth investments in private, well-managed companies in sectors such as consumer, technology and pharmaceuticals, which he expects will benefit from structural change in the domestic Chinese economy.
Victoria Chernykh is director of investment companies at Edison Group