The year of the rat: China’s Economy is strong but investors need to be on their guard

As China enters the Year of the Rat this Saturday (25 January), Jasmine Kang, Portfolio Manager at Comgest, the independent, international asset management group focused on quality growth investing, believes that China’s growth has become more sustainable but that high-quality companies are still rare and strong stock selection is more important than ever in the Year of the Rat:

“The rat might be a shrewd and unpopular creature in our culture but in China it stands for diligence, intelligence, energy, determination and achieving goals, so it is appropriate that it gives its name to a year in which China’s growth model is becoming more sustainable and its equity markets more transparent and open to foreign investors.

“At least economically the gods have been kind to the country in recent years. The shift in the Chinese economy from credit and infrastructure-driven growth to innovation, services and consumer-oriented growth is almost complete and real incomes are growing steadily. The opening of the Shenzhen and Shanghai stock markets is proceeding at a rapid pace and China’s long-term potential as a financial centre is huge. Although the share of foreign investors in Chinese A shares is still low, foreign institutional investors’ access to the Shanghai and Shenzhen stock markets will continue to advance in the coming years, promoting capital inflows and professionalising the capital market. The improvement of transparency and ESG issues is still in its infancy, but more companies are already reporting in accordance with international standards.

“Despite the positive changes in the general environment, China remains a challenging place for stock picking. High-quality companies still seem few and far between. In China it is particularly important for minority shareholders to be in the same boat as the company’s decision-makers and managers. Governance structures are of crucial importance for the success of long-term oriented quality growth investors. Investors should have a diligent rat-like squint at potential investments to see if their growth is underpinned by strong and open governance structures.

“Shandong Weigao Group Medical Polymer Co., Ltd is a prime example of how improvements in governance structure favour minority shareholders. The company has long been a strong brand in the market for medical consumables but its growth was below average for a long time. Equity investments were reserved for top management only and were not tradeable. Through the reform of the Chinese capital market, these shares have become tradeable and, thanks to employee participation programs, they have become an important instrument for long-term corporate management and a catalyst for accelerating growth. Earnings per share and the company share price have doubled over the past three years.

“Despite being known for its high volatility, in the long term, the outlook for the Chinese equity market is positive. Over the past 12 months, the IT and healthcare-heavy ’China Shenzhen’ index, with 36% value growth in USD terms, has been one of the best stock markets in the world and has even outperformed the Nasdaq. In the Year of the Rat, investors should keep a sense of proportion and not just chase after rising prices, but rather invest in quality over the long term and be patient to achieve an optimal risk-return profile for their Chinese investment.”