Investing in China White Paper - October 2020 - ABS Global Investments
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Investing in China White Paper October 2020
China: Too Big to Ignore
China’s transformation and rise into an economic power has been one of the most important developments in recent
history. Ranked as the world’s most populous nation, China represents nearly 19% of the world’s population1 with almost
1.4 billion people2. Over the last four decades, the Chinese economy has averaged 9.4% in annual GDP growth3,
transforming the country into the world’s second largest economy and the single largest contributor to world growth
since 2008. This spectacular growth has helped raise over 850 million people out of poverty 4, making China an upper-
middle-income country and the fastest growing consumer market in the world. It has also grown to be the largest
manufacturing base as well as the top exporting country in the world.
Figure 1: Growing Share of World GDP (1980 – 2019, based on PPP)
100%
36% 30% 25%
42% 42%
17% 15%
50% 22% 22% 20%
40% 40%
35% 32% 36%
2% 4% 7% 14% 19%
0%
1980 1990 2000 2010 2019
China Other Emerging Markets United States Other Developed Markets
Source: IMF as of Oct 2019
Figure 2: 10 Largest World Stock Exchanges by Market Capitalization
8. London 4. Shanghai
9. TMX Group $2.4 T Stock Stock
$3.5 T Exchange 3. Japan
Exchange
$20.4 T Exchange
6. Euronext $4.6T $6.0 T Group
1. New York Stock $6.3 T
Exchange
$2.4 T
$17.2 T $4.8 T $5.5 T
2. NASDAQ 9. Saudi
Stock 7. Shenzhen 5. Hong Kong
Exchange Stock Stock
Exchange Exchange
The three Chinese Exchanges together
$16.6T represent $16.6T in market capitalization
Source: World Federation of Exchanges as of August 2020
The Chinese stock market has matched the pace of the country’s economic growth. Today, China’s three stock
exchanges together represent $16.6 trillion in market capitalization and are second in size only to the United States5. In
addition, China is home to second largest unicorn 6 market in the world. As these companies go public, the Chinese
market capitalization will continue to rise. However, despite the size of China’s population, its role in global growth and
size of equity markets, China continues to be underrepresented in global indices and investor portfolios.
33% While China
represents 17% of the market cap of world exchanges , it only represents 6% of the MSCI AC World Index8.
7
Figure 3: Global Indices Are Underweight Chinese Equities
20%
7% 34%
67% 41%
Share of Share of Share of 17% Percent of 6%
19% 19%
World World GDP Global MSCI AC
Population (based on World
33% Index
PPP) 63% Market Cap
40% 87%
14%
China Other Emerging Markets Developed Markets
Source: World Federation of Exchanges
Source: IMF as of Oct 2019 Source: IMF as of Oct 2019 Source: MSCI as of August 2020
as of August 2020
1Accessing China: Making Sense of the Alphabet Soup
Accessing the Chinese equity market can seem complex to investors faced with its numerous available investment
routes: A-shares, B-Shares, H-shares, Red Chips, P-Shares and US listed ADRs. These investment options vary greatly
by stock exchange membership, currency, liquidity and access as shown in figure 4.
Figure 4: Understanding the Alphabet Soup: China’s Various Share Classes
Chinese stocks listed in Mainland Chinese stocks listed in Hong Kong Chinese stocks
China listed in the US
A-shares B-Shares H-shares Red-Chips P-Chips US ADRs
Definition Chinese Chinese Chinese Chinese securities Nonstate-owned Shares of
securities securities securities incorporated Chinese Chinese
incorporated in incorporated in incorporated in outside of China, securities companies that
Mainland China, Mainland China, Mainland China, listed in Hong Kong, incorporated are listed in the
listed in China listed in China listed in Hong but whose primary outside the US
(legacy market) Kong (excluding business interests mainland and
dual-listed stocks are in mainland traded in Hong
like Alibaba) China. Usually Kong
controlled by the
state or a province
or municipality
Stock Shanghai and Shanghai & Hong Kong Stock Hong Kong Stock Hong Kong Stock NYSE/NASDAQ
Exchange Shenzhen Stock Shenzhen Stock Exchange Exchange (HKD) Exchange (HKD) (USD)
Exchange Exchange
Currency Quoted in Quoted in foreign Quoted and Quoted and traded Quoted and Quoted and
renminbi currencies traded in Hong in Hong Kong dollar traded in Hong traded in US
(Shanghai in Kong dollar Kong dollar dollar
USD and
Shenzhen in
HKD)
Market 10,187 18 724 601 1,534 1,279
Capitalization
(USD B)
Number of 3,858 94 287 177 706 247
Stocks
Access QFII or Stock No restrictions No restrictions No restrictions No restrictions No restrictions
Connect
Main Sectors / Financials, Industrials, real Financials, SOEs – utilities, Consumer, real Internet,
& Industries consumer, TMT, estate, consumer energy, telecom, real estate estate, IT healthcare,
healthcare industrials, TMT consumer disc.
Top Moutai, ICBC, Gujing Distillery, China China Mobile, Tencent, Alibaba, JD,
Companies Agricultural Baosight Construction CNOOC, China Meituan, Xiaomi Pingduoduo
Bank Software, Bank, Ping An Resources Land
Luijiazui Fin & Insurance, ICBC
Trade
Source: CICC, HK Stock Exchange, Shanghai Stock Exchange, MSCI. As of Sep 30, 2020
For Hong Kong-listed stocks and US-listed Chinese ADRs, investors are free to trade with little restrictions. However,
quota systems and capital controls in mainland China historically created challenges for foreigners to access stocks
listed in Shanghai and Shenzhen stock exchanges. Many of these hurdles have been minimized over recent years.
Today, foreigners seeking to access A-shares may do so via Qualified Foreign Institutional Investors (QFII) program or
2Stock Connect (via HK Stock Exchange). Further changes to allow foreign investors easier application of QFII licenses
are expected in the near future and should augment the access to China securities.
Figure 5: How to Access A-Shares
Qualified Foreign Institutional Investors (QFII) Stock Connect (via HK Stock Exchange)
Description Program that allows specified licensed international Schemes that allow access to mainland listed stocks
investors to participate in mainland China's stock through the Hong Kong stock exchange (Shanghai-HK
exchanges. Created in 2002. and Shenzhen-HK Stock Connect). First created in
2014.
Qualification Fund managers, pensions, insurance companies with All foreign investors including individuals
$500m AUM + 2 years of operating history
Quota All quota abolished in Sep 2019 No total quota. Daily quota CNY52B
Approval agencies CSRC for investment license and SAFE for foreign None
exchange license
Investment universe All listed securities 579 stocks as of Aug 2020
Limits on repatriation No restriction but subject to regulatory approval None
including audit, tax and FX
Source: HK Stock Exchange and CICC.
Why An All China Approach Makes Sense
Although there are many ways to access the Chinese equity markets, the size, dynamics and composition of Chinese
investment options vary greatly. The universe of stocks outside mainland China is just a small part of the universe. More
specifically, A-shares represent a $10.1 trillion market compared to $2.8 trillion in the Hong Kong market and $1.3
trillion in the ADR market. Investors focused exclusively on H-shares and ADRs limit their universe to 1,417 stocks and
exclude the additional 3,800+ stocks within in the A-share universe.
Unlike the H-share and ADR markets, institutional investor participation is relatively low in the A-share market with the
retail investors having a large influence both on the free float and trading volume. This retail focus is accompanied by
higher trading volume which in turn has resulted in Chinese mainland markets ranking among the most liquid in the
world. Share turnover velocity in Shenzen and Shanghai stock exchanges are 465% and 266% respectively, while the
Hong Kong stock exchange’s turnover velocity is closer to 60%9.
Looking through to the underlying listed companies, the A-share market tends to be more diverse than the H-share and
ADR market. H-shares have traditionally been dominated by the largest state-owned companies such as banks, energy
and telecom companies while ADRs have tended to focus on new economy companies such as Alibaba and Baidu.
Examples of sectors that are typically unavailable outside the A-share market include consumer goods and services,
health care, and media. Expanding the investment universe to include a wider array of investment options across China’s
various share classes allows investors the flexibility to take advantage of opportunities across the different industries,
sectors and market capitalization.
3Figure 6: The A-Share Market is More diverse than the H-share and ADR Market
Utilities, 2.6% Utilities, 3.2% Real Estate, 5.9%
Real Estate, 3.0%
Real Estate, 10.3%
Materials, 9.7% Materials, 1.7% Info. Tech., 1.7%
Info. Tech., 3.8%
Industrials, 1.7%
Industrials, 6.0% Health Care, 2.4%
Info. Tech., 17.5% Health Care, 5.9%
Financials, 1.5%
Financials, 16.6% Energy, 3.4%
Industrials, 16.7%
Energy, 1.6%
Cons. Staples, 4.9%
Health Care, 11.4%
Financials, 13.3%
Energy, 1.1%
Cons. Discr., 29.3% Cons. Discr., 64.7%
Cons. Staples, 12.9%
Cons. Discr., 8.9%
Comm. Srvs., 3.0% Comm. Srvs., 16.8% Comm. Srvs., 18.5%
China A-Shares Hong Kong Exchange Chinese ADRs
Source: Bloomberg as of September 2020
As access to mainland stocks improved, index providers such as MSCI and FTSE have included A-shares into its major
indices, however with restrictions that artificially limit their representation within the indices. For example, in the case of
MSCI indices, A-shares were first added in October 2018 with a 5% inclusion factor. As of September 2020, inclusion
has increased to 20% and is limited to 472 large- and mid-cap stocks out of a universe of over 3800 A-shares10. A
comparison of the MSCI China Index and MSCI China All Shares Index demonstrate the differences between artificially
limiting exposure to China share classes.
Figure 7: MSCI China vs MSCI China All Shares vs Chinese Market
27
34% 20%
22% 9% Mainland China A-
Shares
12%
MSCI MSCI China
HK Listed Chinese
China Total Companies
China 37%
All Shares Market Cap
Index Index 41%
US Listed hinese
Companies 61%
54% 71%
Source: MSCI and Bloomberg as of September 2020
China Opportunity for Active Managers
Despite their size and growing importance, Chinese equity markets remain relatively inefficient and offer fertile
opportunities for active managers with local insights to add value.
Under-owned
Although investor interest in Chinese equities have increased materially over the last few years as restrictions for
investments in A-shares have been relaxed, foreign ownership levels are still significantly below levels seen in developed
and emerging markets. With global indices expected to continue to relax artificial limitations on Chinese equities, it is
reasonable to expect large scale foreign inflows into A-shares in the coming years.
4Figure 8: Foreign Ownership of Domestic Stock Market
40%
35%
30%
25%
20%
15%
10%
5%
0%
Hong Kong Korea Japan Taiwan Average EM Brazil US Mainland China
(A-Shares)
Source: Wind, Bloomberg and HSBC Qianhai Securities of 12/09/2019
Figure 9: 2019 Household Asset Structure (China vs US)
100%
Real Estate
80% Bond
60% Stocks
40% Inv Funds, Insurance,
Pensions and Private equity
20% Cash and deposits
0% Other
China US
Source: CEIC, CICC Research
Domestic inflows to A-shares is also expected to increase. As of 2019, 66% of Chinese household assets are allocated
to real estate with less than 10% allocation to equities compared to 29% in the US11. With homeownership in China
reaching 90% and the government increasing restrictions on real estate as an investment tool (and thus limiting its
return potential) Chinese households are left with little choice but to increase allocation to equities in the future.
Inefficient & Volatile
Despite relatively low allocation to equities, the A-share market is dominated by retail investors who own 55% of the
free float of the market and account for over 85% of trading volume12. These retail investors tend to have short
investment horizons and be more focused on recent price action than company fundamentals. The hyperactive nature
of domestic investors and the resulting volatility often generate opportunities for patient skilled active investors that are
better positioned to generate alpha.
Figure 10: Retail Investors Dominate the A-Share Market: Turnover Contribution by Investor Type
100%
80%
60%
40%
20%
0%
China A-Shares China H-Shares US UK
Retail Investors Institutional Investors
Source: As of May 1, 2018. Lazard and South China Morning Post. https://www.scmp.com/business/ money/markets-investing/article/2144194/global-investors-take-their-
positions-ahead-chinas
5Under- Researched
Sell-side analyst coverage of A-shares tends to be relatively low creating pricing inefficiencies to be exploited by active
managers. Over 50% of the A-share market is not covered by third-party analyst.
Figure 11: China A-Shares are Under-Researched
60% 53%
Analyst Coverage of
50%
China A-Shares
40%
30% 23% 24%
20%
10%
0%
No analyst coverage 1-5 analysts 6 or more analysts
Source: Factset Research Systems as of December 31, 2019. Total size of universe included in the analysis is 4,925 companies
High Dispersion
Finally, the A-share market offers relatively high levels of dispersion which mean that skillful active managers have a
better opportunity to add value thru bottom-up stock selection.
Figure 12: The China A- Shares Market Offers Dispersion of Returns for Active Investors
10%
Average Cross-Sectional
(Oct 2014- Dec 2018)
8%
Dispersion
6%
4%
2%
0%
MSCI China A CSI 300 FTSE 250 Nikkei 225 HSCEI S&P 500 FTSE 100
International
Source: Pinebridge, Source: Bloomberg, as of 31 December 2018. MSCI China A International Index was launched in October 2014, thus the coverage period is from 31
October 2014 to 31 December 2018. https://www.pinebridge.com/insights/investing/2019/03/alpha -in-china-a-shares
Accessing Local Specialists in China
The Chinese asset management industry has experienced unprecedented growth over the past ten years, reaching
$16 trillion by the end of 201913. The pace of growth is expected to accelerate further with the recent liberalization of
the investment banking and money management industries. According to Oliver Wyman Consulting, the A-share asset
management industry is expected to grow to as much as $30 trillion by 2023 driven by domestic and foreign inflows 14.
While the current industry is already large, it is also very fragmented with over 24,000 privately managed funds spread
across 36+ provinces and cities, with an average AUM of $114M 15. As a result, searching for local specialists requires
a strong network and experienced research team to select the right managers.
While the Chinese equity market offers great opportunities for active management, experienced locally based managers
typically have a better chance of transforming those opportunities into alpha for their investors. Deep local knowledge
is critical in understanding the changing local macro and micro economic undercurrents as well as changes to the equity
market dynamics such as new issues, investor flows and index changes. In addition, a fluent understanding of the local
6culture and language are critical tools for selecting the right stocks and sectors to take advantage of the high dispersion
and inefficiency in the market.
Figure 13: Very Large but Highly Fragmented Asset Management Universe
Large & Diverse Universe Highly Fragmented Geographically Dispersed
24,000+ $114M 36
Number of privately managed funds Average size of privately managed Number of provinces/cities where
funds privately managed funds are located
9,000
Number of pure equity privately 2% 56%
managed funds Percentage of privately managed Percent of privately managed funds
funds managing more than $750M based in Shanghai, Shenzhen and
Beijing
Source: The Asset Management Association of China, May 2020
Conclusion
China is a large, growing economy with a deep, diverse and liquid market that is growing in global importance. Despite
these promising attributes, China still has relatively low institutional ownership and coverage, which create inefficiencies
in its equity market. The opportunity to add value and generate alpha is significant for skilled active managers with deep
knowledge of the universe and a local presence. While there are few dedicated players offshore, locally the asset
management industry is large, fragmented, and often comes accompanied with travel and language challenges. As
such, the importance of experience in finding trusted local partners in the region is essential and will determine investors’
success in taking advantage of the extraordinary opportunity that China offers.
7Important Notes & Disclosures
This presentation shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified investor
receives a final confidential private offering memorandum (the “Fund Documents”) describing an opportunity to invest with ABS (a “Fund”). In the
event of any inconsistency between this presentation and the Fund Documents, the Fund Documents will govern. This presentation being provided
to a prospective investor does not guarantee an investor’s qualification for an investment in the Fund or the Fund’s capacity for its investment. Such
criteria may only be determined upon completion of the Subscription Material for the Fund. Investments in any Fund will be suitable only for certain
financially sophisticated investors who have no need for immediate liquidity in their investment and can bear the risk of an investment in the Funds for
an extended period of time. There is no secondary market for interests or shares in the Funds and none is expected to develop. There are also
restrictions on transferring interests or shares and withdrawing or redeeming interests or shares from the Funds. The information herein is not
intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. You should make an
independent investigation of the investment described herein, including consulting your tax, legal, accounting, or other advisors about the matters
discussed herein. Information pertaining to our processes is subject to change at any time without notice.
Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be
used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute
investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied upon as such.
Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI
information is provided on an “as if” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of
its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”)
expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement,
merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI
Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other
damages. (www.msci.com)
1 Source: IMF as of October 2019
2 Source: National Bureau of Statistics of China. As of 2019
3 Source: World Bank. Data from 1978-2019
4 Source: World Bank. Data accessed as of 2020
5 Source: World Federation of Exchanges as of August 2020
6 Footnote: Unicorn is the term used in the venture capital industry to describe a startup company with a value of over $1 billion. According to CB
insights, China unicorns are valued at $504 B second only to US ones ($684 B).
7 Source: ABS and World Federation of Exchanges as of August 2020
8 Source: MSCI as of August 2020
9 Source: World Federation of Exchanges as of August 2020
10 Source: MSCI as of 2019
11 Source: CEIC, CICC Research
12 Source: Stock Exchange
13 Source: Oliver Wyman Consulting and the World Economic Forum. Report: China Asset Management at an Inflection Point. As of July 2020
14 Ibid
15 Source: The Asset Management Association of China, May 2020
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