According to Baring Asset Management, the secular growth of China is one of the most significant themes for investors around the world. Khiem Do, investment manager of the Baring China Absolute Return Fund, believes that Asian economic fundamentals are stronger and more stable than they have been for years. This is fuelled by the remarkable changes in China, the re-awakening of Japan and an increasing amount of intra-regional trade.
“The outlook for Asian markets is so promising that we believe the financial imbalances in the US economy are much more serious than any potential threat posed to investors in Asia,” says Khiem Do. “In particular, investors should embrace the cyclical nature of the Chinese economy to benefit from the strengthening economic environment.”
China continues to operate in an environment of strong growth, low inflation and easy monetary policy, he says. The government continues to implement reforms and restructuring in order to boost corporate efficiency and the A-share market. The upward pressure on the Renminbi remains and this is supportive of continuing foreign exchange flows in the Hong Kong-China financial markets.
The recent emergence of hedge funds focused either on individual country markets, to take advantage of the investment opportunities presented there, or utilising different investment strategies such as relative value or distressed debt, are a clear sign of the growing liquidity and depth of the Asian market.
Based on the desire to generate positive absolute returns for investors without the cyclicality traditionally associated with China-related markets, Barings launched a China long / short equity hedge fund in July 2004. Khiem Do explains that investing directly in the domestic markets of China and Hong Kong is not the only way to play the China growth story; “It is important to remember that investing in companies listed overseas which export raw materials to China can provide real value. This is a variation of the old story that shopkeepers selling picks and shovels did better than the majority of prospectors during the Californian gold rush.”
The China Absolute Return Fund has the flexibility to invest in regional markets where companies have sufficiently close business links with China.
“There is a common misconception that only a small proportion of the China growth story can be accessed outside the A and B domestic markets,” says Khiem Do. “This is wrong, as there are still world-class companies within the core H share market in Hong Kong – companies such as PetroChina, China Mobile, Zijin Mining and Wu-Mart, as well as some great indirect plays on China and HongKong-based beneficiaries of the explosive growth in the tourist trade since border controls with mainland China were relaxed. These include retailers, property investors and developers, as well as banking stocks.”
Barings is confident that there is ample liquidity in the Chinese market on the short side of the book as well as the long. “There are currently 229 stocks to short in Hong Kong and China, and more if one looks beyond those markets,” according to Khiem Do. “Borrowing costs are reasonable outside the very smallest companies, with a degree of transparency which is as good as any in the western world.”
Barings says the distinctions between A and B shares are gradually blurring. Originally, A shares were for Chinese citizens only, and B shares were for foreign investors. Citizens can now buy B shares too, provided they have legal foreign currency accounts. In the same way, foreign investors can purchase A shares under the qualified foreign institutional investors scheme, although they are limited to no more than 10% of the shares listed and must meet various requirements.
The A share market is large, at around US$500 billion, but has historically been illiquid since most of the shares are held by the government. The B share market is far smaller and is only a fraction of the A share capitalisation. The government is gradually trying to improve the liquidity of both markets with a view to funding future pension liabilities. H shares are similar to B shares in that they are issued by Chinese companies and designed for purchase by foreigners, the difference being that they are listed in Hong Kong. H shares are additionally sometimes bought by investment banks to help make a market in these shares by creating depository receipts listed in the US or UK (ADRs in the US, GDRs in the UK).