Investing in China

Investing in China

China is one of the largest and fastest growing markets globally, but investors have not been able to take full advantage – until now.

Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

 


Discover the China opportunity

Much is changing in China and this has material implications for all investors, whether individuals or large, and or sophisticated institutional investors. The cost of ignoring this emerging opportunity might prove too high, especially over the longer term.

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Five myths and realities about investing in China

Foreign investors hold surprisingly few Chinese equities given the fact that it is the second biggest stock market and third biggest bond market globally. Some investors have been held back by views that may be either misguided or outdated. That means it is a good time to re-examine the case for investing in China. Here are five commonly-held myths about the investment landscape. Read on to find out why the perceived realities are often far from the truth.

  • REALITY: Three-quarters of China’s 6.6% GDP growth in 2018 was consumption related1 

    China’s old economic model relied on exports and investment to fuel growth, but now services and domestic consumption are leading, and exports have fallen below 20%1 of total output.

    GDP drivers are changing 

    Chart depicting exports as a percentage of GDP growth.

    We see China’s growth prospects closely aligned with home-grown brands that can compete in quality, design and functionality with luxury brands such as Apple iPhones, Lexus cars, Gucci bags and L'Oréal perfumes for which there is high demand. The allure to consumers: lower prices attached to the domestic alternatives.

  • REALITY: Chinese corporations have increased debt loads, but household and government debt look in check by global levels.

    In the decade following the Global Financial Crisis, low-cost financing helped Chinese debt expand almost five-fold to US$33trn in 20182. Local governments and enterprises binged on infrastructure and home buyers took on mortgages in an effort to beat property price inflation. Noting the issue, the government initiated deleveraging efforts in 2017, and successfully held debt-to-GDP levels flat in 2018, while avoiding social unrest and systematic financial stress. The chart Is China in too much debt? shows the low share of household and government debt relative to total debt in China. 

    Corporate bond defaults rose from 0.2% in 2017 to 0.8%3 in 2018, but even this is relatively low compared to most developing economies. The silver lining? Worried bond investors can cause mispricings, potentially creating opportunities to generate alpha from thoroughly assessing the creditworthiness of individual issuers. 

    China’s government and corporations rely mostly on domestic Yuan financing. Total external (mostly US dollar) debt is about US$2 trillion, representing 15% of GDP and 65% of foreign exchange reserves4. In short, we see China as well positioned to service its US dollar debt.

    Is China in too much debt? Maybe not.

    Chart depicting debt composition in various regions as a percent of GDP.

    Source: BIS, as of 31 December 2018.

  • REALITY: Alternative data sources are abundant and provide real-time updates. 

    Some investors wonder about the accuracy of official Chinese data. However, there are alternative sources — such as satellite imagery, mobile payments and online marketplace volumes — that can guide and inform an investment decision alongside official data. 

    For example, tracking movements of metallic matter on the ground is a way to estimate factory build-ups or expansions by region. 

    The chart below shows that while the long-term trend is aligned, we can identify gaps and potential investment opportunities over certain shorter-time horizons. 

    Official and unofficial data together paint a clearer picture

    Chart depicting activity through satellite image vs. official PMI, 2009-2019.

    Source: SpaceKnow, BlackRock, as of 28 February 2019, for illustrative purposes only.

  • REALITY: Privately-owned-enterprises drive Chinese growth, innovation, and job creation 

    In 2019, the number of mainland Chinese companies on the Fortune Global 500 was nearly equal to that of the number of US companies for the first time5

    While SOEs comprise the majority of these Chinese companies, many private sector corporates are also on the list: internet giants Tencent, Alibaba and JD.com; consumer electronic makers Xiaomi; insurance firms Ping An and Taikang, to list a few. Private companies in China are generally smaller compared to SOEs, but typically more efficient and profitable. In aggregate, private companies contribute over 50% of corporate taxes, 60% of GDP, 70% of technology innovations, 80% of urban employment and 90% of new jobs6

    The government regards SOEs as the backbone of the Chinese economy but recognises the key role played by the private sector, especially during economic downturns. Recent stimulative measures, such as tax cuts, further support private companies, helping boost growth and innovation have helped make them more attractive to investors. In late 2018, Beijing cut taxes, reduced funding cost, and streamlined administrative processes to support private companies. And in 2019, the tax burden is expected to drop further for small businesses with annual profits under three million yuan, 98% of which are privately owned7.

  • REALITY: Infrastructure development in China has long-term social and economic goals. 

    China’s annual infrastructure budget exceeded US$2.6 trillion in 20188, and the country operates some of the world’s largest and most developed rail, highway, subway, and telecom systems. It is estimated that the $2.1 trillion worth of Public-Private-Partnership (PPP) infrastructure projects have an average investment return of 6.5-7.0%9

    This may seem low for infrastructure investments, yet not all projects yield the same results. The economic rate of return of China’s high-speed rail is as high as 8.0%10, despite the lower-cost for Chinese consumers – see the chart More kilometres for your yuan. The World Bank has praised the system on multiple fronts, including travellers’ cost and time savings, greenhouse gas emissions, road congestion and regional economic development. 

    Growth of infrastructure investment slowed to low-single-digits in 2018-19 from an annual rate of about 20% in the previous five years11. We see this ratcheting up again as policymakers focus on the country’s long-term competitiveness. In developed coastal provinces, such as Zhejiang and Guangdong, the government is focusing on “smart infrastructure,” including logistics facilities for e-commerce and electricity charging facilities for the 5G network and electric vehicles. 

    More kilometres for your yuan

    Chart depicting fares of high-speed rail systems per kilometre in various countries.

    Source: China’s High-Speed Rail Development report, the World Bank, June 2019.

Five reasons to invest in China

1. A possible once-in-a-generation opportunity

The gradual inclusion of China’s domestic equity and bond markets into the main indices represents the possibility of a once-in-a-generation opportunity for investors, with the related investment flows estimated to reach US$ 250 billion by the end of 20201.

2. A market that is too large to ignore

China is already the world’s second largest economy and the world’s second largest stock and bond market2, both are expected to grow rapidly as the Chinese economy continues to expand.

3. A structurally under-owned market

Despite these capital inflows, global portfolios remain structurally under-invested with foreign ownership currently accounting for 3% of the broad market3.

4. A source of meaningful diversification

China’s domestic bond and equity markets offer exposure to a different opportunity set as reflected by the low correlation in returns between the China A-shares and developed equity markets and the Chinese and developed government bond markets4.

5. A growing range of potential exposures

Focusing on the current trade tensions between the US and China can mask the speed at which the Chinese economy is rebalancing towards domestic consumption, as evidenced by the fact that 75% of GDP growth is now consumption related4. This transition in turn is creating a range of new opportunities in the onshore markets.

Our latest insights on investing in China

  • China’s onshore equity markets

    05-Sep-2019 | By Gerald Garvey, PhD | BlackRock | Jeff Shen, PhD | Rui Zhao, PhD, CFA

    China’s onshore equity market may benefit in the coming years from the relatively fast pace of economic activity.

  • Forty years of manufacturing change

    04-Feb-2019 | By BlackRock

    China’s structural reform journey has been unprecedented in scale, time frame and breadth of accomplishments.

  • Chinese equities: Is 3% enough?

    25-Oct-2018 | By Jeff Shen, PhD | Rui Zhao, PhD, CFA

    Although China’s economy is an engine of global growth, most institutional investors have only minimal exposure to China.