This video presents some unique insights from our local investment teams on the outlook for the country’s equity
markets. They discuss some of the forces that could affect opportunities for investors, including:
They also share how they integrate environmental, social and governance (ESG) factors into their investment decisions
and why it matters.
View transcript
Given the exceptionally strong performance of China’s equity market last year, what are your
expectations for 2021?
I think China definitely did well in 2020.
It was up 27% compared to other markets. U.S. was up 20%. Europe was flat. It was the second-best
performing, I think, among the EM countries. And where we are now, I would say fundamentals are holding up
pretty well. Some of that might be optical, like it’s from a low base in 2020, et cetera, but many
economical metrics do look good even compared to 2019 levels. In fact, some of the short-term indicators
have never been better. The TSF number, PMI numbers, both surprised the market on the upsides.
For the full year, I think consumption growth we’re looking at 12% to 13%. Exports mid-teens. All very
solid. So I would say fundamentals are good.
But there are headwinds for the equity market, and the most prominent one would be policy and regulation
headwinds we saw in some of the sectors. Most evident would be the internet sector. We’ve seen
anti-monopoly roles coming out and that’s hindering some of the major names like BABA, Tencent, and
Meituan. And it’s not just the internet sector, unfortunately. There are other sectors like property
and education, so on and so forth. So that would be one headwind.
And also you mentioned valuation. 2020 we saw pretty much the only thing was multiple expansion, and
that’s likely to reverse. In most sectors, we are seeing historical high valuations except for
sectors, maybe banks or big oil names. So some are frankly—some of these multiple expansions are
frankly not justifiable. To give you an example, we don’t even need to talk about fancy internet
names. Some of the stable companies were trading at 80 to 100 times for P/E where their historical high end
was mid-30s.
So that’s going to change. And also liquidity. Globally, you’ve seen obviously U.S. interest
rates are picking up, and that has led to higher liquidity situations everywhere. And in China, we’ve
seen liquidity turns tight as well as we go into the Chinese New Year.
And so full year credit growth, we’re looking at low-teens. So certainly with that, it will be
increasingly hard to square the high valuation we’ve seen versus the trend in liquidity. So I think
that’ll be challenged for the remainder of the year 2021 as well.
So I think in short, some of the investment logic in 2020 will reverse in 2021, such as excessive liquidity,
pandemic play such as internet, work-from-home, vaccines, et cetera.
But if we look from the brighter side, in the short term we have had that 20% correction in China since
mid-February, and now we’re flat compared to year start versus, I think, MSCI World’s up 10%,
10% to 15% year to date. So the hot momentum has calmed and valuation has become more palatable.
And another thing is, if you look at the long term, a lot of the secular growth we’re looking at are
still there, and then a lot of the structural theses we’re looking at such as household income
allocation more to the equity market, those still stand.
So this year we just need to do a lot more bottom-up research and find the companies we like. This I think
is a perfect entry point that’s being provided to us. So 2021 would be a good opportunity for us to
select the companies we like for the long term.
From an investment standpoint, how does slowing globalization impact China and the rest of Asia?
I think it makes it more challenging.
It’s certainly true that in the last few years since the Trump presidency, but now it appears to be a
bipartisan issue or supported directive in trying to make sure that, or trying to see China as the strategic
competitor as opposed to more of a friendly ally. And the U.S. and China have gone down a certain route of
seeing each other as protagonists as opposed to a relationship that was probably, in the last 15 years, a
little bit more cooperative.
We don’t see that really changing. I do think that this anti-globalization trend does appear here to
stay. It’s not just about the U.S. and China; we’re seeing popular or populist movements across
the world, whether it be in Europe, India. The rise of the strongman. And it is certainly going to make
investments more challenging.
What we see it is, is a change in economic relationships from a much more multipolar or multilateral trading
system to a more unipolar or bilateral trading systems developing.
What does that mean? I think it definitely makes it more challenging for China in certain respects, the most
obvious ones being technology transfers or getting access to higher levels of tech, especially if the U.S.
puts sanctions in on certain companies transferring technology to local domestic Chinese companies.
But does it mean that China’s going to be isolated, which in theory could be a U.S. strategic
objective, much like the Cold War saw the Soviet Union isolated? We think it’s highly unlikely. The
Soviet Union had an economy that was much more reliant on one single factor, oil, whereas the Chinese
economy’s incredibly diversified. And most importantly, over the last 15, 20 years, the Chinese
government has made it—part of its ingrained into its own policies to try and increase trading
relationships with a lot of countries around the world.
And the reason we think that while we may see a more separated global economy, i.e., an anti-globalized
global economy where the U.S. has one pole and maybe China has another pole, it’s very hard for a lot
of countries around the world to extricate themselves from a China relationship even if they wanted to. More
than half the countries in the world, the main trading partner that they have now in terms of dollars and in
terms of import-export relationships is actually China, not the United States.
So even if the United States remains politically powerful and says we want to try and isolate China,
it’s going to be very hard to convince even allies to do that. So we think that while there are
definitely going to be changes with the way countries interact with each other and it’s going to make
investing a slightly more complicated thing to think about, we do think that China will remain an investable
asset class and it will be very hard for people to ignore it as an investment, or to an asset allocator to
completely ignore China in the next 10 to 15 years.
Will the Chinese government’s “Belt and Road” initiative continue to present compelling
investment opportunities?
So the Belt and Road started in 2013. And if we look at total investment related to that, it really peaked
in 2016 and ‘17, which was when China was easing liquidity conditions to help restart the economy. But
since 2018, as China tightens liquidity to control debt, BRI investment has dropped substantially. So before
2018, we look at the total investment. It used to be really ports-driven, railway, power plants. Very
capital intensive.
So now if we look at that type of investment, it’s actually very hard to fit in a China portfolio.
Lots of companies [that] benefit are like China construction companies or railway companies. The earnings
look very good, but they are also what we call deep value because they’ve permanently got cash flow
and receivable issues, so it’s practically uninvestable.
So basically since 2018 and going to 2019, you can already see this big drop of investments. And on top of
that in 2020 we have this pandemic and more defaults, more issue of repayments of debt. And obviously there
are other things like geopolitical ambiance has changed, and China’s own priority is more inwards
towards its own structural issues, all of that.
I guess China at this point has realized also being the biggest creditor to these countries, most notably
the Southeast Asian countries, Central Asia or African countries, make it also very difficult for China to
seize the assets or to get paid back. So the lendings on the BRI has become restrained and also the concept
has shifted as well.
So Belt and Road hasn’t been abandoned. The Chinese government will be able to reframe it very easily.
For example, a lot of the health care-related assistance they give to the Southeast Asian countries or
African countries, now they’ll be able to put that under the category of Belt and Road initiatives.
And also they’re talking about the digital Belt and Road, which are exporting digital knowhow and then
apps and internet platforms, et cetera.
So I think Belt and Road is going to be one of the top leader, Xi Jinping, his signature geopolitical
policies. So it’s not going to go away, and because the framework has been expanded so the investment
opportunities for us is actually ample. But the good thing is, it’s not just limited to construction
companies or the big national SOEs, which is actually a more amicable environment for us to invest or to
choose from.
How do ESG factors weigh in to your decision-making process for investments in China?
RBC globally, and for all our investment teams, have a requirement to integrate ESG factors into our equity
investments. So it’s a part of our process. It’s integrated within our process. When we look at
any company, we will make qualitative and quantitative assessments on a variety of sub questions with
respect to environmental, social, and governance factors.
Now these things vary when we look at different companies in different sectors. But from a very top-down
perspective, we think about governance being multifaceted. Looking at things like management quality,
management objectives and incentives, sustainability of a business. We look at accounting, and think of that
from a quantitative perspective as being very important to understand whether a business is acting in a
sustainable fashion.
And of course then we do a lot of work, which is more qualitative based, asking the right questions of
management and we run things called checklists, which basically have a number of formulaic questions that we
are expected to ask management to make sure that we understand holistically a business and the industry
it’s in and whether we think long term these businesses are going to achieve the sustainable metrics
that we think are important.
And this is important for a number of reasons. Firstly, our investors want us to do this. And we know who
are our investors are, and they think this is important and we think it’s important.
Secondly, the sustainability of a business long-term is important from any investor’s perspective.
There’s no point buying a company if you’re worried about a permanent or temporary impairment of
your invested capital in that business because they can’t meet the environmental, social, or
governance objectives appropriately.
And we don’t want to come in one day and have a headline in front of us saying this company is doing
this and, therefore, it’s no longer investable. So we need to make sure that we do all of our work,
and we need to make sure we do it well.
Specifically with regards to China, it’s very easy to pick on China because of a lot of negative
headlines around the world. Some of these are related to accounting issues. And there have been some very
notable frauds in China and we are aware of that. We use a number of different metrics to analyze our
companies from a quantitative perspective. We use third-party forensic accountants to comb through the
financials to try and make sure we’re not getting hoodwinked or investing in companies that may not be
outright frauds, but borrowing aggressively from earnings in the future.
That’s more of an accounting issue or management quality issue. There is obviously also a broader
issue that is being much more played out in the world media at the moment. Things like what’s
happening in Xinjiang. And these are much more difficult questions to answer and ask, actually, to our
companies. There are also obviously cultural issues that we must be aware of when you’re in it, and
there are differences between Eastern culture and Western culture that we must understand.
But overall what we do try and do is make sure we avoid controversy and understand our companies and the
risks that they’re taking. So a lot of Chinese companies will intrinsically be connected with certain
parts of the economy that Western investors may find uncomfortable or troubling. And our rhema is really to
make sure that our portfolio overall is defensible and make sure that the capital that we’re investing
for investors is not at risk because of poor practices by the companies we invest in.
Our philosophy, fortunately, is very, one of looking for companies of a high quality. Returns on invested
capital are very important to us. And these businesses tend to, therefore, avoid a lot of the particularly
environmental issues that people can be concerned about, say carbon issues and so on. But also when it comes
to other issues such as use of forced labour and so on, we do make sure that we ask the right questions of
companies to ensure as best we can that we avoid such issues going forward.
But it is difficult, and sometimes it can be quite emotional, but these are all things that is part of our
job. We have to make sure that we are mitigating risk, and that’s often how we look at ESG in this
part of the world. We look at is as a risk mitigation exercise to make sure we’re not going to lose
our clients’ money.