Local retail investors in the mainland China ‘A’ share markets seemed to decide to sell stocks en masse at the beginning of 2016 ahead of the removal of a ban on major shareholders selling shares, which was imposed during the market sell off in mid-2015. The ensuing panic selling has led to the new circuit breaker mechanism kicking in twice to halt market trading this week. Investor sentiment has also been dampened by a weaker-than-expected December Purchasing Managers’ Indices manufacturing survey, coupled with further depreciation of the renminbi. As mainland markets are driven by local retail investors who tend to have a shorter holding period, we have often seen extreme moves in Shanghai. It is not clear if the new circuit breakers that halt trading (for 15 minutes when the market falls by 5%, and trading for the day when it falls 7%) will actually reduce volatility.
It’s about where you invest
Recent stock market reform has eased access to the mainland ‘A’ share markets, but like most foreign investors, the vast majority of the Chinese shares we invest in are listed in Hong Kong. Shanghai and Shenzhen-listed ‘A’ shares generally make up between 5% and 10% of our portfolios. The Hong Kong traded shares are still subject to the same macroeconomic factors but these ‘H’ shares tend to have more reasonable valuations, and lower volatility compared to ‘A’ shares (our portfolios had around 70% invested in ‘H’ shares as at 31 December 2015).
ADRs: less value but earnings still growing
We also favour US-listed Chinese stocks, also known as ADRs (American depositary receipts*), which comprise around 15% of our current holdings). The beneficial trend of US-listed Chinese companies being acquired by large or controlling shareholders appears to be continuing. Furthermore, since 1 December 2015, MSCI has included overseas-listed shares such as ADRs in their China indices, improving the quality of the region’s investible indices. While some of the value that was apparent in US-listed Chinese shares after the August 2015 sell off has gone, we think many of these companies are still generating attractive earnings growth.
Current opportunities
In our opinion, Chinese banks currently do not represent a value investment opportunity given the current operating and regulatory environment. Within the onshore Shanghai and Shenzhen 'A' markets, we are finding pockets of value in large capitalisation companies and automobile-related sectors, which continue to receive support from policy measures. We also favour unfashionable sectors, such as the makers of baijiu, the traditional Chinese liquor where we have a position in liquor manufacturer, Kweichow Moutai.
Our mantra remains consistent − in times of continued volatility and difficult headlines, it pays to quietly accumulate well-run businesses that panicked investors are indiscriminately selling.
*Note: ADR (American Depositary Receipt) is a negotiable certificate issued by a US bank that is backed by physical stock held by the issuing bank. Each ADR represents a specified number of shares in a foreign stock that is traded on a US exchange.
