China's objectives are a question that's top of mind for many of our clients in recent months. While anything is possible, we don't think punishing foreign investors or moving all listings back to China are the goals. Though some listings may move to Hong Kong, Shanghai, or Shenzhen, that process is not straightforward. It will only occur if the US and China cannot resolve their regulatory disclosure differences. But before we get to that, let's take a broader look at why the regulatory crackdown in China is happening and what the Chinese government is trying to accomplish.
The regulatory regime change has caught many investors by surprise, but if we look closely, we'll find that many of the issues are not dissimilar to challenges voiced in the US and Europe. The difference is that China is obviously a less transparent environment and acts decisively without public debate. It's hard to know what's being discussed and when decisions are to be expected, with the latest bout of evidence of this fact creating a crisis of confidence by the world's investors.
Technology giant loopholes
All these issues exist in the US and Europe and are debated daily. But, with China's distinct and non-transparent approach, they have decided to act now rather than discuss. We would not be surprised if, after a robust democratic debate, a similar "reigning in of tech giants" comes to the western hemisphere in a few years.
These are random, not predictable, and will continue to happen. But issues like this are to be expected in a country trying to wean itself from a wild east mentality. Similar investigations occur in other countries, and nowhere do investors cry foul. The punishments also need to be put in perspective. Alibaba was fined US$3 billion for monopolistic behavior (with cash on hand at the time of ~US$70 billion), and Ant Financial was ordered to convert to a financial holding company with separate businesses and relevant licenses (and permitted to continue operations). Even Didi remains listed and continues to operate.
The geopolitical aspects of the regulatory regime change are likely to unfold over the coming decade, not the next few months. With wage growth comes the risk that Chinese manufacturers become less competitive than their counterparts in Southeast Asia and Latin America. With a focus on consumer technology, dependency on essential hardware components becomes critical. We can expect to see policy shifts to promote key technology areas - factory automation, 5G and AI technologies, semiconductor manufacturing, environmental technologies, etc. This pivot has to be funded and encouraged but cannot be done with additional credit as before. It will come at the expense of mature and "non-critical" industries that China does not consider fundamental to continuing its rise.
These challenges should sound familiar to US and European investors. Replace Alibaba with Amazon, Didi with Uber, Tencent with Facebook. Remember Intel's market share loss to Taiwan/Korea? And the resulting concern from US politicians? It does not sound too different at all. The key to finding opportunities in change is understanding these challenges and the transition China is trying to undertake.
Every three to five years, China suffers a crisis of investability confidence by foreign investors. Aggressive bull markets occurred in 2000, 2006, 2009, 2015, 2020 and were followed by flat or bear-market behavior in-between. But the overall trend has been up and benefited investors willing to diversify globally.
Onshore Chinese stocks (measured by the CSI 300 index) have delivered 13.2% per year in USD since 2004, compared with 10.4% for the S&P 500. Without a doubt, that higher return came with more volatility. Much like China policy, which has fewer checks and balances than the US, the market tends to overreact often because so many retail investors are involved. After the aggressive bull markets end, Chinese stocks often become quite cheap, and institutional/patient investors can take advantage of new opportunities in generating significant returns.
Below are a few charts showing China's valuations today, making clear the potential opportunity for investors. Long-term, stocks follow GDP growth, and though China is slowing, it is still growing quicker than most major economies. Though Chinese stocks can be volatile, that volatility has trended to the upside in terms of returns, rewarding long-term investors.
While dual-listings are likely, complete US de-listings and China re-listings are not straightforward and won't happen overnight. Alibaba is a prime example. Instead of delisting in the US, they simply became dual-listed and added a Hong Kong listing. Why? Foreign investors own approximately half the market cap, which means someone would need to pay US$200 billion or more to buy out the US listing. A dual-listing and maybe an eventual conversion from US shares to Hong Kong shares make more sense. The US and other global investors can own Hong Kong, and China would be happier with a listing there than in New York. This dual-listing process is likely to repeat in the coming years, especially if the US and China cannot resolve their differences over financial regulations and disclosures. Ultimately, however, US-sourced capital is not a huge portion of Chinese funding, and moving it all to Hong Kong or mainland China won't be a huge hit.
The last few months have not been pleasant, but we do not believe China is out to get foreign investors, nor do they want their market to be uninvestable. However, they do want to address many of the same problems that the rest of the world is experiencing and prioritize domestic rather than international investor needs.
So, the easy trade may be obvious - close China positions and ignore that market from now on. Alternatively, the more challenging but potentially more long-term rewarding trade is positioning portfolios for a "dual spheres of influence" world. The US / China relationship will define the 21st century, but it is not a zero-sum game. The US will continue to dominate in many areas and China will start to dominate in some as well; making it important to allocate to both markets and ensure that portfolios don not have zero exposure to a 1.5 billion person nation. However, the key for us as investors is not to blindly own "China" but to understand the exposures we are taking and how they align with national objectives and priorities.
Aleksey Mironenko is Global Head of Investment Solutions at Leo Wealth, an independent global wealth advisor. Based in Hong Kong, Aleksey is responsible for constructing client portfolios and overseeing the firm’s investment function. He is a strong believer in cost-efficient portfolio construction and asset allocation as the primary drivers of investor returns and thrives on achieving meaningful results and providing considered counsel to clients.
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to the accuracy, completeness or reliability of this information. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth or the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
Disclosures: This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results.
Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.
Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.