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China’s common prosperity obsession leaves investors in a return twilight zone

30 November 2021 Gareth Stokes

Equity investors with heavy exposure to China will want to put 2021 behind them following a 12-month period of seemingly absurd policymaking by that country’s ruling Communist Party. It was a year during which regulators made repeated forays into both the business and financial market environments, causing untold financial harm to asset managers, entrepreneurs, investors and shareholders alike. Their actions, or so it is reported, are aimed at protecting the common prosperity goals that are part of the Communist Party manifesto.

A less-appetising slice of growth

Asset managers have, for years, been rushing to get their slice of China’s growth dividend. They have dived headlong into the country’s financial services, retail and technology industries in the hope of profiting from the exponential growth in China’s middle class. Historic returns have been so handsome that portfolio managers have been able to turn a blind eye to the risks inherent in centralist policymaking and the sketchy financial structures that have been created to accommodate Western capital. But as any motorist will tell you: charge through the amber warning light at an intersection enough times, and you will get sideswiped! 

China has produced more shocks in the last 12-18 months than this writer cares to mention; but we will single out a few of the ‘lowlights’, starting with the heavy-handed sequence of slaps dished out to Alibaba.com founder and dollar billionaire Jack Ma. In November last year, Ma’s ambitious dual listing of Ant Group on the Shanghai and Hong Kong exchange was indefinitely postponed, just one day after Chinese regulators called him and other Ant executives to an urgent meeting. But China was not done with Ma. In April 2021, they served his alter ego, e-commerce titan Alibaba, with a record US$2.8 billion anti-trust fine. The firm’s main crime, according to New York Times: “exclusionary practices that hindered competition in online retail, affected innovation in the internet economy and harmed consumers’ interests”. 

Tech firms wrestle regulatory Armageddon

This staggering penalty came soon after the February 2021 introduction of anti-monopoly guidelines that were aimed mainly at China’s tech giants. Firms like Huawei, JD.com, China Mobile, Alibaba and Tencent must have spent most of 2021 in perpetual fear of the next regulatory intervention. Around July, they learned of strict listing rules for any companies that boasted more than a million users. And then, shock horror, came a decision that literally stripped the concept of capitalism from the private education sector… Towards the end of July, the regulators announced that all private tutoring firms would have to operate as not-for-profits. 

The kids who make use of private tuitions services will have plenty of time to dedicate to their studies. In a move that left this writer cold, the Chinese government then introduced a policy to limit how much time children could spend on online games. Tech giants were instructed to restrict the youth’s access to popular online gaming platforms to no more than three hours a week. Do the math yourself by reflecting on how much time you spend on television or social media each week and contemplate how a three-hour cap would affect your life! As mentioned in the opening paragraphs, the list of enforcement actions and new regulations is endless. No industry is safe, and no business activity left untouched. Even Didi, a ride-hailing challenger to Uber, was punished by having its user app removed from a number of app stores. 

Bleeding trillions of dollars…

Investors were properly spooked. At one point in 2021 the headlines screamed that over a trillion dollars had been knocked off the market capitalisation of China’s technology giants. By the time of writing, end-November 2021, the MSCI China Index was down 17% compared to a 29% gain on the US S&P500, and 13% gain from the UK FTSE100. Selloff or not, China remains a very important factor for all markets globally. “Wherever you are invested, you will have some China exposure,” said Gyongyi King, Chief Investment Officer at Alexander Forbes Investments, during a 2022 investment outlook discussion. “Global resource and technology companies are all affected by the economic situation and growth prospects in that country”. 

Alexander Forbes, like many of its peers, dedicated a significant portion of its 2022 outlook presentation to China’s prospects. The bad news for South African investors, who have significant exposure to the Chinese economy through Naspers, is that the investment manager expects China’s regulatory clampdown to persist. According to King, investors can expect ongoing volatility as the Chinese government works towards its long-term common prosperity goal. And there are other challenges too. “There is definitely a residential property bubble, as illustrated by the Evergrande credit crisis,” King said. Other themes that will affect market returns include the ongoing clampdown on monopolies in the tech sector; the country’s 2060 commitment to net-zero carbon emissions; and the aforementioned common prosperity theme. 

Unique approaches to investing in China

It is up to individual asset managers to map an approach to China. Sanlam Investments, which holds Naspers in certain of its SA equity funds, recently commented that they addressed concerns about China’s ongoing regulatory interference by discounting their fair value calculation for Naspers. Alexander Forbes, meanwhile, said that a clear understanding of the rationale behind the regulatory push was needed to “drive investment success in China” going forward. “These regulatory risks are nothing new; they have just been quite topical this year from a news flow perspective,” concluded King. “From time to time, the Chinese government will impose regulations on companies that they see as being monopolistic and / or [a threat to] the common prosperity theme”. 

What happens next is anyone’s guess. But King is confident that China’s regulatory cycle will continue, at least through 2022. This sentiment was confirmed in an article published by Bloomberg, early November 2021, in which Robert Frost suggested that President Xi Jinping had “a long list of unresolved issues that could yet have a wide-ranging impact on industries and financial markets alike”. The investment community will be watching nervously to learn how much Didi is fined for raising money via a US listing; discover the outcomes and enforcement actions following corruption probes into China’s financial sector; and find out more about new Chinese property taxes, among other issues.

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