Turning the corner?
China’s recent five-year plan signposted financial market reform as a key priority – new investment opportunities are already appearing.
Since Mao Zedong first declared the founding of the People’s Republic of China in 1949, party bigwigs have, in true Communist fashion, gathered in Beijing once every five years to agree policy priorities for the next political term.
The thirteenth such meeting took place in the Chinese capital in October. Mao himself would have been deeply unimpressed to discover the commitment that the current administration has made to deepening its financial markets, as well as to opening them up to the world. In fact, China has already been making decisive moves towards freer financial markets in recent months.
Perhaps most important of all, at the start of its recent gathering, Beijing signalled its intention for the renminbi to become an international reserve currency. But it has also fostered more specific links abroad, agreeing stock market tie-ups with Germany and the UK, as well as between the Shanghai and Hong Kong markets.
Foreign listings have also increased, in both directions: China’s domestic bond market has been further opened to foreign investors, while China itself has chosen to issue both sovereign bonds and bank bonds in renminbi in London. As the assembly was coming to an end, China’s central bank announced further measures to increase currency convertibility.
Yet, amid the opportunities, risks abound and memories of the Shanghai Composite index’s August dive are still fresh.
“The opening of the A-share market – both in Shenzhen and Shanghai – increases the supply of companies and we continue to review them,” said Ajay Krishnan of Wasatch Advisors. “However, when one looks at the valuation of those shares, they’re not cheap. In the high-quality universe, they are trading at 30 or 40 times their value, so they are definitely not cheap.”
Yet while mainland stocks remain very expensive, the potential stock price boost created by financial market reform can be accessed less expensively through Hong Kong. You might therefore think the financial sector would provide a very attractive investment opportunity – you can even buy Chinese banks in London, after all. Yet here again selectivity is key.
“One way to play the liberalization of the financial markets would be through asset managers like Value Partners,” said Krishnan, referring to a 20-year-old Hong Kong asset manager. “We have always been cautious on Chinese banks because of the lack of transparency on the loan books. I would look at insurance companies and leasing companies before I look at the banks.”
Full details of China’s thirteenth five-year plan will not be published until March 2016. But one early detail, that was announced as the meeting was about to begin, is the plan to internationalise the renminbi, enabling it to be included in the IMF’s Special Drawing Rights basket of major international currencies. Accession to the IMF basket would mark the renminbi as a mature, global currency, leading to major currency inflows and providing an extra buffer of stability for investors.
This ambition can only be realised in tandem with financial market reform and opening up, as the communiqué implies. One inevitable beneficiary will be China’s bond market.
“The primary goal of any financial market reform in China is to support the ongoing campaign by the Chinese government to internationalise the renminbi,” said Jim Veneau, head of fixed income at AXA Investment Managers. “While offshore issuance of dim sum bonds [renminbi bonds issued outside China] in new markets like London raises the profile of renminbi-denominated investments, the offshore bond market is a small fraction of the onshore bond market.”
Internationalisation of the Chinese currency will help Beijing to address a number of urgent challenges. Growth has been slowing in recent years, and the World Bank forecast puts 2015 growth below 7% - China has only seen annual growth drop below 7% once in the past two decades.
But capital markets will have deeper pockets in the long run, and provide better built-in due diligence too. As financial market reform accelerates, domestic companies will turn to China’s emerging capital markets in much greater numbers. Investors should be watching closely.
The opinions expressed are those of Ajay Krishnan of Wasatch Advisors and Jim Veneau of AXA Investment Managers and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.