Focus on new markets: China ‘A’ Shares

The launch of a new Nasdaq-style market for technology companies in China last week, reminds us of the ongoing innovation in Asia. Whilst Witan Pacific is not yet invested in this rather speculative ‘STAR’ market, we consider one of the new markets in which Witan Pacific’s managers are finding opportunities.

The investment opportunity in China, as with much of the rest of Asia, is one of modernisation and evolution from a rural agrarian society to an urban, manufacturing and service-led economy. This has led to a growing middle-class with ever increasing educational standards, higher disposable incomes and the resulting growth in domestic demand. Following the opening of the Chinese market in 1978 and the subsequent economic reforms, these trends have created an environment where domestic companies have not only grown and expanded but also become increasingly accessible to outside investors.

In the early days of the Shanghai Stock Exchange, the market’s casino-like qualities made it a no-go zone for serious investors. It was also fiendishly complex to access, rife with corporate mismanagement and suffered from a lack of transparency. Foreign investors seeking access to Chinese public companies typically invested in shares listed in Hong Kong where corporate governance standards were higher. However, developments over the last few years have enabled foreign (institutional) investors to access the many high quality local businesses which are now well placed to benefit from the all-important increase in middle-class spending, forecast to double from $7trn to $14 trn in the next decade (the comparable figure for the US is currently $5trn).

China’s primary domestic stock market, based in Shanghai and Shenzhen, is known as the ‘A’ Share market. The ‘A’ Share market, which used to be the preserve of local short-term traders, is now a conduit for serious international investment. A catalyst for this evolution is the opening of the Stock Connect system (a collaboration between the Hong Kong and Shanghai exchanges) to allow international and Mainland Chinese investors to trade securities in each other's markets and the subsequent inclusion of local Chinese securities in global equity indices. This has helped to improve liquidity, transparency and ESG issues, making the market more appealing to long-term investors. Of course, not all the companies listed on the ‘A’ Share market meet the high standards required by our managers so selectivity (especially in corporate governance and valuation terms) is required. Although relatively new, the ‘A’ Share market is no minnow. It is ranked second largest in the world by market capitalisation, albeit roughly half that of the USA, making it hard to ignore for both global and regional investors.

The ‘A’ Share market is home to over 4,000 companies with a combined market capitalisation of $8.4trn (that’s twice the size of the UK stock market) and 70% of all Chinese companies are listed exclusively on the ‘A’ Share market. The ‘A’ Share market dwarfs all other ways of investing in Chinese businesses including via the US and Hong Kong exchanges, although these still host State-owned enterprises (SOEs) including banking, infrastructure and telecoms giants as well as the internet behemoths; Tencent, Alibaba and Baidu. The ‘A’ Share market provides broad sector exposure with it making up most of the c. $12trn invested in Chinese entities listed globally. All four of Witan Pacific’s managers can access the ‘A’ Share market via Stock Connect and each of them is dedicating additional resources to identify, analyse and invest in some of the exciting opportunities to be found there.

While the opportunities are clear, we should stress that these are early days for Witan Pacific’s ‘A’ Share investment which, at present, makes up a small proportion of the portfolio. We do, however, believe that Witan Pacific’s pan-Asian approach provides the broadest possible exposure to such opportunities allowing our managers to take advantage of secular growth without having all their eggs in one Chinese basket, which, despite its recent maturation, is likely to remain volatile as speculative and geopolitical pressures ebb and flow within the system.

James Hart, Investment Director of Witan Investment Services

 

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