Investors could take flight from China in the Year of the Rooster

The IMF has forecast China’s GDP to rise from six per cent last year to 6.5 per cent in 2017 but many are concerned that the newly elected President Donald Trump may commence a trade war with China which would have repercussions across the world.

Often such figures are based on information supplied by China. Yet some have expressed concern over the veracity of such information and only this month the governor of Liaoning admitted officials had not given truthful statistics for 2011-2014.

The Chinese economy has grown rapidly since economic reforms were introduced in 1978. Then ranked as the ninth largest economy, it saw dramatic average growth of 9.4 per cent to 2012. By 2013, by becoming the world’s manufacturing hub together with stimulus measures in 2008, China had become the second biggest economy in the world.

The measures supported investment programmes, driving a need for commodities, but household consumption remained low. This has led to policy changes to create a more balanced economy, which has reduced the level of growth.

Chris Price at Leeds stockbrokers Redmayne-Bentley says that a “lack of knowledge of many Chinese companies may deter investors”, as well as the currency as the renminbi is pegged to the US dollar, meaning that sterling savers have to factor in exchange rate fluctuations.

An indirect way to gain exposure to China is via commodity stocks as the country is such a major consumer of copper and iron. For a direct investment, a collective will not only have the benefit of a professional manager but is generally cheaper and easier than purchasing individual stocks.

Two investment trusts are tipped by Price: Fidelity China Special Situations and JP Morgan Chinese. The former, started by manager Anthony Bolton, has large holdings in e-commerce firm Alibaba, China Petroleum, Citic Telecom International and healthcare group, Hutchinson China Meditech. With assets of almost £1bn, the trust announced last year that it would increase its unlisted companies from five to 10 per cent.

At £146m, the JP Morgan fund is far smaller, trades on a significant discount (meaning assets can be acquired for less than their original purchase) and includes Hong Kong and Taiwan in its holdings. Among its shares are China Taiping Insurance, Ping An Insurance and the internet services provider, Tencent.

Jonathan Baker, investment director at broker Charles Stanley in Leeds, says a more diversified approach is preferred to a direct allocation in China. He likes Guinness Asian Equity Income where around one quarter is allocated to China, such as the non-state owned China Minsheng Banking and clothing manufacturer and wholesaler, China Lilang.

For clients seeking more involvement, Baker favours First State China Growth, which he expects to outperform its benchmark over the medium to long term, and for a tracker, the HSBC MSCI China Index. This exchange traded fund follows the largest 160 companies with full replication.

Martin Payne at wealth manager Brewin Dolphin notes the severe capital outflows from China this month. He says: “It is very hard to see China winning a trade war with the US when they are net recipients of trade-related flows around $30bn per month.” China could allow its currency to depreciate sharply.

Two funds are selected by Payne: First State China Growth for a concentrated portfolio of 40-50 stocks and an outstanding long-term track record and the JP Morgan Chinese where over half is invested in financial and IT-related stocks.

“There is undoubtedly huge growth potential in China,” says Garry Ibison, chartered financial planner at adviser Chase de Vere in Leeds, part of Swiss Life. He notes that in 2004, around 40 per cent of the population lived in developed urban areas and today the level is 60 per cent, many of whom are well educated.

Whilst manufacturing output gains the most attention, services actually form a larger proportion of GDP in China. Ibison warns that there are risks, notably variable levels of corporate governance and limited transparency “which can make it difficult for investors to have real confidence.” He is concerned over the Chinese banking system with ownership mostly state-controlled and very high levels of bad debt.

Ibison does not recommend any specific Chinese funds, preferring exposure through more broad-based emerging market funds, such as JP Morgan Emerging Markets (with 25 per cent in China), Fidelity Emerging Markets (16 per cent) and Standard Life Global Emerging Markets Equity Income (24 per cent).

Jason Hollands, from Tilney Bestinvest, advisers to Saga clients, is more blunt: “I would be extremely wary of investing in China as deep cracks are appearing in its economic model. While China is often perceived as a country that has retained a Communist political system but effectively embraced capitalism, the latter is merely a cosmetic veneer. It’s phoney capitalism.”
 To obtain limited exposure, Hollands favours a fund which uses derivatives to protect the downside, such as Schroder Asian Total Return, an investment trust with 21 per cent in mainland China and 25 per cent in Hong Kong.

He says that a number of funds they hold in high regard are “aggressively underweight” in China, preferring India: Stewart Investors Asia Pacific Leaders, Pacific Asset Trust and JP Morgan Emerging Markets.

“The underlying problems in China are still lurking under the surface,” says Jonathan Jackson of independent advisers Patronus Partners, who adds that the main driver of GDP growth has been a rapid expansion in credit. He predicts China will have to go through a default cycle which could have significant implications not only for China-centric investments but, owing to its global significance all financial markets.

Jackson forecasts “a managed, bumpy slowdown” at best. For those seeking exposure, he favours Fidelity China Special Situations Fund, which currently has a significant discount.

None of the concerns Darius McDermott at Chelsea Financial Services had a year ago have gone away and says more have been added. He says China’s debt to GDP is 260 per cent and is a massive problem and Trump’s protectionist trade stance worrying, given how much of China’s growth over the decade has come from cheap exports.

Yet with a population of 1.4bn – four times the size of the US – with an expanding middle class, China’s “potential for consumer spending growth is enormous”. McDermott spots green shoots with healthcare, education, auto sales and entertainment. His favoured funds are First State China Growth and Invesco Perpetual Hong Kong & China.