China’s Regulatory Crackdown
30 JUL 2021
The ongoing regulatory crackdown in the technology and education sector in China has not escaped our notice. This anxiety has spread to the wider market, and the MSCI China benchmark is down 13% in July. Large internet stocks have fallen over 20% before rebounding slightly, whilst some education stocks focusing on after-school tutoring or core-stage education have fallen by as much as 70%.
We have significant Asian and Emerging Market exposure across clients’ portfolios and have been constructive on these markets for some time. Naturally, China makes up a large percentage of this allocation, with the average weight across our funds at c.35% in Asia and 38% in EM. This translates to between 3%-8% exposure to China, depending on the risk profile you follow. We believe this is a comfortable level and currently do not plan to change this, although this could alter should we see any material events to change our view.
Increased regulatory scrutiny by the Chinese government is not a new thing and has been a feature of the market for some time. We do not think this impairs the growth potential for many of their leading companies, or that the recent moves show that China does not want to have good, profitable, and large businesses listed and operating in their country. In fact, the additional regulatory scrutiny could be a benefit for incumbents, which entrench their position as market leaders by increasing barriers to entry.
The obvious exception to this is the regulation concerning the education industry, which will most likely kill-off the after-school tutoring and core-stage private education businesses. Concerning this, our fund managers have pointed to the importance of investing in businesses which are adding benefits to society that would not be expected to be provided by the state or would not be possible to be built by the state. The added emphasis being put on ESG factors by the market, and our fund managers in recent times will go some way to avoiding these risks. We have seen, in some cases, this has already had significant performance benefits, with managers divesting from several companies on the basis of poor workers’ rights policies, conflict with government policies and questionable supply chain transparency.
We expect that this will not be the last bout of worry around potential regulation in China, and are aware that the communist government will take a much more aggressive and rapid approach to regulating big technology companies in comparison to the US and other developed markets. However, there are still some very strong reasons to be investing in the country. To name a few, In recent times China has been the largest contributor to the world’s economic growth, the rising middle class is quickly becoming a key market for most global companies, and the innovation seen with many of its private companies is already market leading.
Finally, we are allocating to managers that want to access this growth but will be discerning around choosing companies that not only are financially good investments but also have good governance, manage environmental risk well, and are providing goods and services which fit into the state’s designs for the economy. This gives us confidence to execute our process, which has always been to think long-term, take advantage of volatility in markets where we have a positive view, and to make sure our client’s wealth can grow meaningfully above inflation.
Louis Tambe, CAIA
Senior Investment Analyst
