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6 June 2016

Don't tar all Chinese companies with the same brush

We chat with Mike Shiao, co-manager of Elite Rated Invesco Perpetual Hong Kong & China

Chinese growth is slowing down as we all know but, importantly, there is better quality growth coming through, says Mike Shiao, co-manager of Elite Rated Invesco Perpetual Hong Kong & China fund.

At a meeting with the FundCalibre research team recently, Mike noted, “Whilst the trend may continue downwards over the next few years, I don't think growth will consistently fall below 6%.

“Export and consumption are the two major drivers of GDP (gross domestic product) growth. Chinese market share of exports is still high, despite increasing wages. Even if they are losing the headline export business, they are holding onto the 'behind-the-scenes' parts deals.”

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When it comes to consumption, Mike says the Chinese consumer is actually moving towards spending more on intangible things such as tourism and lifestyle, not just cars and cosmetics. “Spending on the much discussed 'luxury' items only accounts for around 10% of total spending,” he says, “so the slowdown here was more a sign of over exposure; the big brands were opening too many stores in too many cities.”

According to Mike, the headline figures don't tell the whole story either. Regions are more diversified than people assume. Whilst the coastal belt with the big cities accounts for about 51% of GDP growth, other 'problem' areas are far less critical in size.

“The northeast of China, which is traditionally commodity-led and where there is still a lot of overcapacity in the regional economy, only accounts for about 8% of Chinese economic growth, for example,” he says. “Likewise, the areas that have the much fabled 'ghost towns' only make up about 6% of GDP growth.”

Personal, corporate and government debt

The property slowdown, a major concern for many investors, is balancing out due to supply and demand factors, in Mike's opinion. “There won't be a collapse in prices, as the average household isn't over-leveraged when compared to house prices. Property will still be cyclical, but the trend of urbanisation is strong.”

While he also believes that capital protection is still at a good level, he is underweight the financial sector. “Banks have been so profitable in the past that they can absorb a small increase in non-performing loans, he says. “But in reality their current profitability (which is not really growing at the moment) is being hurt more by interest rate factors than by defaulting loans. Banks are already cutting dividends to cover this increasing trend and return on equity figures are falling accordingly.”

“Rising debt is not sustainable,” he continues, “but it needs to be analysed in different elements. Central government debt is sustainable and hasn't increased much as a percentage of GDP. Household debt has not increased either on this measure. But local government debt has seen a considerable increase. Corporate debt has also expanded and the issue is very complex and difficult to tackle.”

“However,” he concludes, “the vastness of China and the Chinese economy is often under appreciated. Too much emphasis is put on China as a whole, and the constituent pieces are all tarred with the same brush.

“If you research individual companies properly, with on-the-ground analysis, you can still find some very good companies that will continue to grow and do well for investors.”

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Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Mike's views are his own and do not constitute financial advice.