China’s economic rebalancing has generated a lot of media ink — and furrowed brows. We at Investec Asset Management believe, however, that investors should look beyond the headlines and focus on understanding the significant structural shifts taking place within China and the exciting long-term opportunities this changed situation presents.
The combined market capitalization of the Shanghai and Shenzhen stock exchanges currently exceeds 50 trillion yuan ($8 trillion), but it still has plenty of room to grow as market liberalization reforms enable foreign capital to buy securities on the mainland exchanges. Over the long term, this anticipated trend should help make the market more liquid and less volatile and provide a compelling argument in favor of larger, long-term allocation to onshore Chinese equities.
Stocks are underrepresented in domestic retail investors’ portfolios, accounting for about 15 percent of Chinese household assets, compared with cash at 54 percent. According to data from the China Household Finance Survey, the majority of Chinese households held no stock at all in early 2015. Although Chinese savers’ overall equity allocation is comparable to those of Japan and some European countries, it is far below that of Taiwan, where retail investors allocate 24 percent of their assets to stocks, and the U.S., where more than one third of household savings is in stocks.
The structural change in the way domestic investors allocate capital should be buoyed by continued economic expansion. Although Chinese gross domestic product growth has halved from more than 14 percent annually in 2007 to approximately 7 percent in 2015, it remains strong. As the economy grows, more domestic savers will have greater assets to invest in the stock market. We believe this dynamic will feed steadily increasing domestic capital flows into the Chinese equity markets.
Foreign investors will also have a role to play in expanding and maturing China’s equity markets. With the launch of the Shanghai–Hong Kong Stock Connect, foreign investors now have freer access to a far larger investment universe than the small number of Chinese firms listed offshore. As more overseas investors investigate this new market, the leading index providers will be encouraged to include domestically listed A shares in their global indexes, which in turn could create a virtuous cycle of foreign investment. But taking advantage of this opportunity is challenging. Today foreign investors own only about 2 percent of the equity listed on China’s domestic stock exchanges, compared with about one quarter in Taiwan and one third in Japan. This investor dynamic results in substantial volatility, which might be unappealing to foreign institutions, but it should not be a reason for long-term investors to shy away from the opportunities presented by China’s economic rebalancing.
As more Chinese savers assign a greater proportion of their assets to stocks and gain greater experience with onshore equities, the markets are likely to become more disciplined and, in our view, volatility will dampen. In the long term, we believe the market will become more mature and more liquid, making the case for a rising allocation to Chinese equities in global portfolios.
Greg Kuhnert is the 4Factor strategy leader of Asian equities at Investec Asset Management, and a contributor to research for the Investec Investment Institute, in London.
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