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Navigating China’s choppy waters
In volatile times, a long/short approach maybe the best way to tap into China’s structural growth opportunities.
Written by
Lan Wang Simond
Senior Investment Manager
Investing in China has always been more like rowing in choppy waters than enjoying a luxury yacht cruise. In recent weeks, conditions appear to have got even stormier, with a spate of regulatory crackdowns, tightening liquidity and slowing economic growth.
We believe caution is justified, but equally that there are still great opportunities to be found for those willing to brave the waves. The main benefit of the long/short approach we follow is that, by combining our stock selection framework with China’s official strategic priorities, we can take advantage of the opportunities the market has to offer while also nullifying potential threats.
One priority area with strong growth prospects is electric vehicles (EVs). Penetration of EVs in China has doubled this year to reach 20 per cent. Crucially, unlike in Europe, that growth has not been driven by subsidies but by genuine organic demand. China sees EVs as an opportunity to make its mark on the global auto market, having lagged behind in traditional petrol-powered vehicles (where Europe had a big head start). And the plan is working: some 70 per cent of EVs in the country are local brands, compared to just 40 per cent for petrol cars.1
The rise of EVs also means increased demand for lithium batteries. Here, China is dominant across the whole supply chain – whether that is base materials, components or battery cells. At the moment, with a global penetration of EVs running at 4 per cent, the world needs 155 GWH of lithium batteries.2 When that rate reaches 50 per cent – which I think will happen before the end of the decade – it will require 25 times more battery power.
The main benefit of the long/short approach is that we can take advantage of the opportunities the market has to offer while nullifying potential threats.
Another area where the opportunities are growing is the consumer sector. Here, demand is growing thanks to shifting consumer preferences towards local brands and the government's focus on improving quality of life.
The market share of local sportswear brands, for example, has risen to 22 per cent in 2020 from 14 per cent in 2012.3 Cosmetics have seen a similar trend. Product quality is improving rapidly too and local brands also have the benefits of being familiar with local tastes and of being able to provide good after-sales service.
Another industry rich in investment opportunities is medicine, in which China is developing a competitive edge..
Its universities produce some 4.7 million engineers every year, which gives it a big advantage in tech-based areas.4 In medtech, China has drawn on its medical knowledge and advanced manufacturing expertise to develop robotic assistants for surgery, as well as high spec ventilators.
Prospects for other parts of economy, such as the Internet sector, are less clear. Which means investors should adopt a more flexible approach. For example, although our overall exposure to the Internet sector is more or less in line with its weighting in the index, we have a mix of long and short positions, being generally more cautious on some of the very biggest companies . A number of them could very well fall foul of China’s anti-monopoly rules. What is more, they are more likely to be ordered to curb output or limit power use in the face of electricity shortages and the pressure on local governments to meet official targets on reducing carbon intensity. So costs may be revised up and growth may slow down. During periods of political and regulatory upheaval, it is important for investors to be realistic over risk control and preservation of capital. But we still believe there are numerous structural opportunities that only China can offer.
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