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Long-term opportunities in China

The trade disagreements between China and the US have been widely reported on in recent months. Fredrik Bjelland, portfolio manager of the emerging markets fund SKAGEN Kon-Tiki, states that it is difficult to analyse what this will mean in the short term, but that a full-scale trade war will of course be negative.

SKAGEN Kon-Tiki has around 15 percent of its portfolio invested in China, and of these positions, only the logistics company Sinotrans (around 1.5 percent of the portfolio) has direct exposure to a trade war. SKAGEN Kon-Tiki’s portfolio managers believe, however, that the company-specific factors in Sinotrans outweigh the trade risk.

The performance of the Chinese stock exchanges have varied greatly this year with the continental stock exchanges of Shanghai and Shenzhen (where the A-shares are traded) down around 17.5 percent and Hong Kong down around 0.8 percent*. Does the fund have a preference when it comes to the different stock exchanges and what is the reason for the divergence in performance?

“We focus on companies and not so much on where they are listed. There are various reasons for the divergence in performance. First, the A shares generally have a higher valuation than the shares in Hong Kong, making them more sensitive to a correction. As for shares that have a double listing in Shanghai or Shenzhen and in Hong Kong, the A-shares trade at an average premium of 18.5 percent. Second, the changed regulations in China’s finance industry, especially for structured products, have had a negative effect on the liquidity in the market. This has resulted in sales pressure on many shares.”

China’s housing market has long been controversial and has been characterised by a high degree of speculation with a large number of so-called ghost cities emerging. What is your view on this? 

“I have lived in China and seen a number of ghost cities and empty development projects. It is clear that three to four years ago there was a big problem with very high supply, particularly in smaller cities. This has fallen sharply over the past two years, and the time between completion and sale has been reduced by about one year. In the case of larger cities, the problem has not been vacant properties, but rather the fact that prices have surged disproportionately, largely driven by speculation. However, the authorities intervened in 2016 and 2017, introducing new rules on debt ratios and how many properties one person is allowed to own. As a result, the price trend slowed dramatically and it is now at a more normalised level of around two to five percent. The market is much healthier today than it was a couple of years ago.” 

Back to equities, is there a particular type of Chinese company you find most interesting? 

“We see good opportunities in A-shares, where there are extremely exciting opportunities in the long term, including consumer and healthcare shares. However, these have been expensive in recent years, so we have been patient and rather bought into more cyclical companies. One example is the air conditioning manufacturer Gree Electrics, which we previously owned when the demand cycle was strong. We recently added kitchen appliance manufacturer Robam to the portfolio. The company is currently experiencing a slowdown due to the quieter housing market, but we believe there will be an improvement in the end consumer market over the next 12-18 months, which will likely lead to a share price rerating.”

The Chinese technology sector has been on an upward trajectory in recent years. Has it caught your interest?

“It is clearly an interesting sector with a lot happening, but valuation is generally higher than we are comfortable with. We actually have exposure to the Chinese technology sector through Naspers, a South African company which owns 30 percent of Tencent. Through this holding we get exposure to a very good company, but at a strongly discounted price considering the value of Nasper’s share in Tencent versus the share price.”

Finally, how do you expect the Chinese stock exchange to develop over the remainder of the year? Will the markets be able to recover if the trade war doesn’t escalate too much?

“Expectations have fallen significantly, but if there is a full-scale trade war it will be difficult for the Chinese market to stabilise, which would of course be negative. Aside from the trade war, Chinese authorities have started to gain control of credit growth and the clean-up currently taking place in the financial system is positive from a longer-term perspective. The banks are now more stable than previously and with high dividends, they appear attractive. I also think that cyclical stocks have become more interesting having fallen significantly in price since April.”

* As measured in EUR as of 20 August 2018.

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