China policy fine-tuning presents buying opportunities
China’s big tech companies are experiencing headwinds. Beijing policymakers have enacted new antitrust regulations which are in contrast to their prior hands-off approach. Despite volatility in China’s tech behemoths – with the dedicated Nasdaq Golden Dragon China Index slipping 34% for the first nine months in 20211 - Mike Shiao, CIO Asia ex Japan of Invesco, believes that this regulatory tightening, similar to what already exists in developed markets, will ensure the proper functioning of an industry that has developed much faster than the laws that govern them.
Why has China abruptly hardened its attitude towards its burgeoning tech companies?
Since the beginning of July, we have witnessed an acceleration in regulations and a refinement of policies in sectors such as ridesharing platforms, online food delivery, and games. The rapidly deployed new regulations should be interpreted as a way to enhance the tech industry's focus on sustainability. In particular, the regulations focus on antitrust rules, fintech, capital markets, data security as well as social equality. We saw the first sign of this shift in attitude last November, when regulators halted the IPO of a fintech subsidiary of a Chinese e-commerce giant. Such actions are actually very similar to those of regulators in developed markets. As China's tech sector has progressed faster than the development of the rules that govern them, Chinese policymakers are expected to continue to refine their policies to ensure a fair environment for the smooth functioning of the industry.
Do you think that companies will therefore be able to adapt successfully to their new regulatory framework?
Yes, they can continue to evolve and develop, prioritizing innovation and creativity in the process. Most internet platforms are private companies which are an essential pillar of Chinese growth - accounting for more than 60% of China’s GDP in 2018 and about 90% of employment in 2019.2 The government does not intend to destroy its technology sector. On the contrary, regulators aim to promote healthy long-term growth. With revenues expected to be resilient for the rest of this year as well as for the next, the risk-reward ratio of Chinese big tech has become attractive again.
How have these trends affected the equity market ?
The market saw an indiscriminate sell-off during July as investors overreacted without differentiating between companies or focusing on their core businesses, creating volatility that drove stocks to levels that were quite far from their fair value. In mid-August, investors started to distinguish winners from losers and many of our quality positions have since rebounded strongly from the panic selling. The market appears to have absorbed much of the negative impact of recent regulatory adjustments, but investors still remain sensitive to market noise.
What is your outlook for the medium to long term?
The sector largely remains strong, supported by a positive outlook as well as strong earnings growth expected for next year. After the recent market corrections, valuations have returned to an attractive level. In early October, MSCI China traded at 12.9x 12-month earnings which compared favorably to the MSCI AC World which traded at 17.7x 12-month earnings.3 In the medium and long term, I believe that the fundamentals of Chinese internet platforms will remain solid and that their competitiveness will remain intact. They will also continue to benefit from the repositioning towards consumption and services.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Debt instruments are exposed to credit risk which is the ability of the borrower to repay the interest and capital on the redemption date.
Changes in interest rates will result in fluctuations in the value of the investment.
When investing in less developed countries, you should be prepared to accept significantly large fluctuations in the value of the investment.
When investing in certain securities listed in China there can be significant regulatory constraints that may affect the liquidity and/or the performance of the investment.
1 Nasdaq Global Indexes, October 2021
2 Goldman Sachs Global Investment Research, August 25, 2021
3 Datastream, I/B/E/S, Goldman Sachs Global Investment Research, Oct 4, 2021
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IM2021-082
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