How Managers Navigate Policy Overhang

Medalist equity managers share their approaches to the uncertainties after China’s regulatory shake-ups.

Kate Lin, CAIA 24 August, 2021 | 14:45
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Portfolio managers investing in Chinese and Asian equities have been taking a holistic view of the recent policy changes, and feel that the reform is more about the region’s long-term development, rather than a short-term measure that will impact a few industries.

 

Broad Policy Agenda

Frank Tsui, senior portfolio manager at Value Partners, says the series of new policies are part of a larger whole. “The policy agenda is now set to achieve quality growth under Chinese President Xi Jinping’s ruling, rather than a high growth rate of some easily scalable sectors.”

Taking the internet sector as an example, he says the mega-scale players enjoyed most of the benefits from the growth of the sector itself, squeezing out the rising players.

“Ensuring a level playing field for everyone is one of the quality ingredients that the Chinese government hopes to see in the economic growth,” explains Tsui, who is on the team that manages Bronze-rated Value Partners Classic Fund. He believes these measures will continue and potentially spread to other sectors.

Fidelity International’s Jing Ning agrees, and points to social and economic imbalances at the heart of the issues the government wants to address. “There have always been social and economic imbalances, and the pandemic has brought these to light. China’s recent policy and regulatory changes are set up to address these imbalances with a focus on security, autonomy and fairness.”

 

Previous Policy Cycles

“Though this regulatory cycle may appear more severe compared with previous cycles, it is important to note that we have been here before,” says Anh Lu, lead portfolio manager for the Asia ex-Japan Equity strategy at T. Rowe Price.

In addition to the most recent round, she cited three occasions – in 2012, 2015 and 2018 – where the market has experienced heightened regulatory tensions during the past decade. “Yet the strategic direction of policy change is clear and has not changed; our team does not think that the end results will be very different this time.”

To the portfolio managers, winners are alike – the companies have been through regulatory shuffles in the past, but brave the challenges to outperform.

 

Finding Safety

Facing the evolving environment, Fidelity’s Ning chooses to side with safety. Sectors that have already gone through the policy reforms are where to find a higher level of security. 

Ning, who manages Bronze-rated Fidelity’s China Focus Fund, says: “China has always been a policy-driven market – companies and industries need to deal with the changing regulatory landscape. But it is probably safer to side with industries that have gone through policy cycles before and companies that have a longer track record.”

“These firms might muddle through this uncertain period better than peers and optimize business models to accommodate new regulations. “

This is in concord with her value-focused approach, which helped her fund brave the market volatility from the year to date. “Cheap valuations, high dividend yields, and strong balance sheets can protect investors from downside risks when the economy faces downward pressure and investors flee from expensive sectors.”

Ning also cautions against sectors that seem ‘safe’ but are prone to have some near-term perils that underlie their valuations. “It’s difficult to predict the future direction of policy changes, but avoiding stocks and sectors that are overvalued can be helpful to mitigate this uncertain period of time.”

As the policy changes lead to market corrections, investors are seen rotating into sectors like healthcare, sportswear, and renewables. In Ning’s opinion, now these sectors are highly overvalued. “Any uncertainty (policy change or not) or deterioration in fundamentals are likely to result into a dramatic de-rating.”

Consistent with her attention to valuation, her portfolio has an overweight position in the financial sector, including banks, which she describes as “a valuation call”.

“After years of de-risking and provision, the [non-performing loan] issue is more manageable today compared to the past. Valuations in the financial sector look depressed compared to global peers and history.”

For T. Rowe Price’s Lu, the emphasis is placed on a company’s plan to attack following a change in the policy environment. “The implication will come down to how each company works to comply with new regulations or even find innovative ways to capitalize on the new environment.” She believes that big platforms that are on the right side of change may emerge as winners.

 

The Other Side of the Coin

Value Partners’ Tsui chooses to find the silver lining by locating the beneficiaries from the quality growth agenda.

“Moving on from the scale growth, China also hopes to shift upward the advanced tech value chain. There has been a self-sufficiency rate to achieve, especially for some of the higher-end technology areas.” According to Tsui, the theme was increasingly critical after the Sino-US trade conflicts, as it propelled China to build a domestic-facing value chain to reduce reliance on the overseas market.

Another example is sportswear. “Health and wellbeing of the people is a cornerstone of the policy that tackles social issues. Encouraging the nationals to be active is one of the measures, which puts local sports apparel at the forefront,” says Tsui, taking also into account the preference for Chinese brands among the millennials and the superior execution of select sportswear brands.

He also reveals that the fund has downsized the holdings of the largest Chinese tech names, as the team believes that the future environment of data usage would impede some of the growth areas core to their main operations. “Though, we didn’t completely exit the e-commerce platforms as they still give out impressive growth that outpaces some other sectors in China.”

According to Tsui, the market took months to regain confidence after the historic policy uncertainties. Before the market seeks a clearer direction, he foresees the broad index to remain under pressure for the rest of 2021. 

 

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Fidelity China Focus A-Acc-HKD16.75 HKD0.54Rating
Value Partners Classic A USD342.70 USD-0.32Rating

About Author

Kate Lin, CAIA

Kate Lin, CAIA  is a Data Journalist for Morningstar Asia, and is based in Hong Kong

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