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Investing in China is even trickier than usual these days, leading some to wonder if it’s worth it. And it’s unlikely to get any easier in the near term, although volatility over the next few months could create good business for long-term investors.
Since the scuttling of Ant Group’s anticipated public offering last fall, Chinese regulators have been targeting the country’s largest and most owned internet companies. On July 2, Beijing struck again by launching a cybersecurity review of
DiDi Global
(ticker: DIDI) and ordering that its app be removed from mobile stores, as it tightened controls over data security and rules for listed companies overseas.
The move, just days after DiDi raised $ 4.4 billion in the year’s biggest IPO, caused the stock to drop a fifth of its value on July 6 and rocked others. Chinese internet stocks. the
KraneShares CSI China Internet
The exchange-traded fund (KWEB) has fallen 15% since June 30, as investors braced for a deeper scrutiny of tech companies’ data practices and other regulatory measures.
“We now know that this is a regulatory minefield, and those who expose themselves to the sector take a lot of volatility,” said Arthur Kroeber, head of research at Gavekal Research. “If your horizon is long term, this is going to be one of the growth stories of the next decade and you have to overcome it. But if you’re shorter term, you can say it’s too complicated and come back in a year when things have calmed down.
The wave of regulatory action has created the kind of uncertainty that attracts bargain hunters. Tech giants like
Alibaba Holding Group
(BABA), whose shares are down 11% this year, are appearing on the radar of value managers. But caution is in order, especially for investors in US-listed equities of Chinese companies. Regulatory pressures could continue. “This is probably just the start of enforcement action,” said Kenneth Zhou, a partner at Beijing law firm WilmerHale.
Fund managers have described China’s regulatory policy as a move to better control and put in place safeguards for fast-growing digital industries and internet titans. It’s also a way for Beijing to deal with escalating US-China tensions, in part resulting from recent legislation in Washington that paves the way for Chinese companies to be deregistered if they don’t come up with more disclosures. audit within three years.
A concern for Chinese regulators: the precious treasures of data collected by Chinese technology companies listed in the United States, creating a potential threat to national security.
“Data control is shaping up to be a major national and geopolitical issue, with direct implications in the equity market for companies operating on both sides of the Pacific,” said Rory Green, head of research on China and the Pacific. Asia at TS Lombard, in a recent study. Note.
Beijing is trying to better control Chinese companies, including those listed abroad. Many of the biggest Chinese technologies, like Alibaba,
Tencent Holdings
(700.Hong Kong) and
JD.com
(JD), are registered in the Cayman Islands and use a variable interest entity structure (VIE), allowing them to bypass Chinese restrictions on foreign ownership. Although largely ignored by investors, the complex structure is a gray area because, under it, foreigners do not actually own a stake in a Chinese company. Instead, they must rely on China to honor the contracts that bind them to the company.
For decades, China largely turned a blind eye to the extralegal structure, but it is paying more attention to it now. Bloomberg News reported last week that Beijing is considering requiring companies that use this structure to seek approval before listing elsewhere. Companies already listed may need to seek approval for any secondary offering.
Analysts and fund managers say they don’t expect China to unravel VIEs, which are used by the country’s biggest and most successful companies and which would take decades to unravel. Many are also skeptical that the United States will follow through on its threat of delisting.
But Beijing could use the scrutiny of VIEs to exert increased control over companies and push back calls from US regulators for more disclosure. Indirectly, the review will likely deepen Beijing’s efforts to attract domestic companies to the country, a dynamic that has already led to secondary listings in Hong Kong for Alibaba,
Yum China Holdings
(YUMC) and JD.com.
Analysts also expect the closer look to slow, if not stop, the number of Chinese companies going public in the United States in the near term. It could also reduce the number of Chinese companies listed in the United States – more than 240 with a combined market value of more than $ 2,000 billion – that appeal to independent retail investors. Any of them unable to get secondary quotes in Hong Kong or China could go private, said Louis Lau, manager of the Brandes Emerging Markets Value fund.
As a result, stocks listed in the United States could experience volatility. Increasingly, fund managers and institutional investors, including Lau, are looking to equities listed in Hong Kong or mainland China whenever possible. For retail investors, the best way to access these foreign quotes, as well as the more domestic-oriented stocks that some fund managers favor, is through mutual or exchange-traded funds.
Fund managers are better placed to deal with some of the logistical complications created by US-China tensions, such as the fallout from a recent executive order banning US investments in companies that Washington says have ties to the military complex. Chinese. The S&P Dow Jones and FTSE Russell indices this month decided to launch more than 20 listed concerns in Shanghai and Shenzhen affected by the order.
Other businesses could also be banned and face similar fallout, with Reuters reporting on July 9 that the Biden administration was considering adding more Chinese entities to the banned list over alleged human rights violations. man in Xinjiang.
As investing in China gets complicated, investors need to choose a fund manager who can handle these complexities and invest locally. Failure to do so could be costly. the
iShares MSCI China A
ETF (CNYA) is up 3% over the past three months, while the
Invesco Golden Dragon China
ETF (PGJ), which focuses on Chinese companies listed in the United States, is down 14% over the same period.
“The regulations are here to stay. Investors will just have to get used to it, ”said Tiffany Hsiao, a seasoned Chinese investor who is a portfolio manager on Artisan’s China Post-Venture strategy. “It’s capitalism with Chinese characteristics. China is obviously still a communist state. It embraces capitalism to spur innovation and improve productivity, but it’s important for highly successful companies to give back to society – and Chinese regulators will remind you. “
As a result, she says, investors need to look beyond the widespread internet titans to find stocks that could benefit from the regulatory scrutiny the giants face. Seasoned investors emphasize selectivity, looking in local markets for companies that are outside the crossfire.
“A company can have good fundamentals and interesting opportunities, but be blinded by government action, which is increasingly active”, explains David Semple, director of the
Emerging markets VanEck
funds (GBFAX). “You need a higher degree of conviction than normal to be involved. “
Semple is looking to companies he knows, in industries that could be affected by regulation, but with less impact than investors realize.
One example: China is targeting after-school providers because it tries to reduce childcare costs and encourage families to have more children. Nevertheless, Semple sees an opportunity in
China Education Group Holdings
(839.Hong Kong), which could make acquisitions as Beijing forces public universities to divest affiliated private universities.
Among the large Internet stocks, Semple favors Tencent, the first position of its fund, compared to Alibaba, another holding. Alibaba faces more competitive pressures, Semple says, and Tencent has an advantage with its Weixin messaging and video game franchises, which provide a high-quality and relatively inexpensive user stream for its other businesses.
Tencent has also quietly complied with government demands, with CEO Ma Huateng keeping a low profile, said Martin Lau, managing partner and portfolio manager at FSSA Investment Managers, which oversees $ 37 billion. That’s positive, given the backlash that met Jack Ma, co-founder of Alibaba and Ant.
The fundamentals of many Chinese internet companies are strong. However, adhering to strict rules on collecting and protecting user data will likely reduce their profits in this area, said Xiaohua Xu, senior analyst at Eastspring Investments.
Alibaba and other internet companies, including JD.com, are cheap enough to attract value investors. But volatility is likely, with investors recalibrating their growth expectations as Beijing puts new rules in place and reviews past deals. In addition, widely held Chinese stocks listed in the United States, including Alibaba, could become proxies for investor angst in China.
Despite the yellow flags, investors have reason to keep China in the mix. “If you buy growth, the world has two engines: the United States and China,” says Jason Hsu, president and chief investment officer of asset manager Rayliant Global Advisors and co-founder of Research Affiliates. But, he adds, the United States is more expensive. “And whenever there is a risk – and the world sees China as risky, with this deepening of that bias – it means an opportunity.”
Write to Reshma Kapadia at [email protected]
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