- Mooted repatriation of ADR listings alter the dynamic of China and Asia benchmarks
- Long term rise of the renminbi a threat to dollar's status as global reserve currency
Rising maturity in China’s capital markets looks set to continue. Restrictions which, in the eyes of the Americans, were needed to redress the balance in trade for goods have failed to halt the progress in China. Indeed, draconian measures put in place by the US to quell the momentum are only stimulating the growth in listings on China’s own exchanges. That’s exciting for investors.
American Depository Receipts (ADRs) have been used by Chinese internet giants like Tencent (NYSE:TCEHY), Alibaba (NYSE:BABA) and JD.com (NYSE:JD) to raise equity finance on the US stock market. The ADRs have been a way for western funds and investors to buy into some of the world’s most exciting companies. Despite having enjoyed a phenomenal bounce back from the market selloffs earlier in the year, these businesses are still much cheaper than American equivalents and therefore still present interesting opportunities for western investors.
“Alibaba and Tencent are growing 20-30 per cent per annum still,” notes Roddy Snell, co-manager at Baillie Gifford’s China Fund, Emerging Markets Leading Companies Fund and Pacific Fund. And he says their core businesses are incredibly good value for that kind of growth on a share price to earnings basis “around 50-75 per cent cheaper than what you’d be paying for a US peer”.
Chinese companies could be discouraged from seeking US listings in future, however. Back in May, the Senate set the ball rolling for legislation that could force the expulsion of foreign companies from US stock exchanges if they failed to comply with American regulatory audits.
“The US is in some ways shooting itself in the foot,” says Mr Snell. “It’s been a risk some very large world class companies will simply cease to list in the country and move back towards China. And China will welcome them back with open arms.”
Secondary listings in Hong Kong have been successful for Alibaba (HK:9988), Tencent (HK:0700) and JD.com (HK:9618) and there is plenty of incentive for investors to follow them east. In the opinion of Robin Parbrook, co-manager of Schroder Asian Total Returns, Hong Kong offers the best value for stock pickers from a bottom-up perspective.
There are three types of China shares: ADRs, Hong Kong ‘H’-shares and the mainland ‘A’-shares listed on the Shanghai and Shenzhen exchanges. The A-shares have been chased up by Chinese retail investors and now look uncomfortably expensive. But potentially shifting the emphasis from ADRs to Hong Kong provides another interesting dynamic. “If the US-listed China stocks relist to Hong Kong they become available to Chinese retail investors via the Southbound Connect”, explains Mr Parbrook. In turn this could “divert some of the money being punted by mainland retail investors and take the heat out of A-shares and boost up valuations in the Hong Kong market”.
More important than where a company lists, however, is whether the primary drivers of the business can underpin sustainable growth. Today investors should focus on the value of a company’s intellectual property – its patents, brand, websites and people.
The book value of a company that has mass disruption in its industry is not a good indicator it will rerate to the upside, as there is potential for these assets to be impaired or even stranded. “We want companies that are growing their IP, their intangible assets. That’s where you’re going to get the real share price performance.”, says Mr Parbrook.
More asset light, high quality businesses are expected to go public on Chinese markets soon, which adds to the attraction. These include Lufax, the financial services and peer-to-peer lending company which already has an ADR listing (NYSE:LU). Investors will also be waiting for fintech leviathan Ant Group to make the world record initial public offering that was postponed so dramatically by regulators. Although asserting its authority over Ant’s majority owner Jack Ma was a prime motive for the delay, the government could have other reasons. After all, some fintech lending models do raise the spectre of the shadow banking China has worked hard to rein in since 2015.
Further antitrust developments are a concern. On 10 November, Chinese regulators announced measures targeting internet giants and Bloomberg estimates $200bn was wiped off the value of Chinese tech companies’ various listings on the news. The Hang Seng index in Hong Kong alone fell 5 per cent.
Despite set-backs China’s capital markets are becoming ever more important
Secured forms of corporate debt have continued to expand, although fears of a hard landing are overblown in Mr Snell’s opinion. He asserts that in his analysis of companies the “quality of growth in China is some of the best we’ve seen in the past decade”.
Along with the expansion of listings on its equity exchanges, China is opening its $16 trillion onshore bond market. This is part of a carefully managed liberalisation of capital controls that is making its currency, the renminbi, an ever more important asset.
That has far-reaching consequences. If the renminbi gets strong enough to become a global reserve currency and challenge the dollar, an economic pillar of American power might crumble. For investors, whatever teething troubles there might be, having well-managed exposure to China is likely to be a wise move for the long term.
