5 reasons to focus on China’s A-shares

The World Bank described the pace of growth in China as the fastest sustained expansion by a major economy in history: China is the world’s 2nd largest economy and with its population of 1.4 billion people, China represents about 18 percent of humanity. Since China began to open-up and reform its economy in 1978, GDP growth has averaged almost 10 percent a year, and more than 800 million people have been lifted out of poverty. Even after a recent slowdown, China’s economy is growing 6–7% a year, which remains high by the standards of most middle-income economies. That`s about 2x the growth of other large economies. As a result, China is expected to contribute more than 20% of the world’s economic growth over the next five-year period, according to an IMF forecast.

(As an interesting aside, China was already the world's largest economy in 1820, accounting for an estimated 32.9% of global GDP, according to a study by economist Angus Maddison. Foreign and civil wars, internal strife, ineffective governments, natural disasters (some of which were man-made), and distortive economic policies caused China's share of global GDP on a purchasing power parity (PPP) basis to shrink significantly.)

Sources:
https://sgp.fas.org/crs/row/RL33534.pdf
https://www.worldbank.org/en/country/china/overview

Since opening up in 1978, China has become the world’s largest international trader of manufacturing goods and the second-largest trader in services (Source: WIPO), and consequently also the world champion in exports. Economic reforms and trade and investment liberalization have helped transform China into a major trading power.

China’s exports soared by 17% annually in the past two decades in dollar terms. In total, Chinese merchandise exports rose from USD14 billion in 1979 to USD2.59 trillion in 2018. That’s an increase by a factor of 185. Merchandise imports grew from USD18 billion to USD2.1 trillion (x116.6). The value of China's manufacturing on a gross value-added basis was 49.2 percent higher than the U.S. level in 2016.

https://www.everycrsreport.com/reports/RL33534.html#_Toc12530868

But the story continues, China’s next transformation is well under way. Services have already taken over manufacturing as the largest share of GDP and are now the largest contributor to GDP growth. In addition, China has managed to reinvent its economic profile from a manufacturer to an innovative leader with a strong focus on new technologies. China and its corporates are among the leaders in future industries like e-commerce, artificial intelligence, fintech, high-speed trains, renewable energy, electric cars, 5G, Blockchain, and solar energy. As a result, China was also the biggest source of applications for international patents in the world in 2020 for the second consecutive year after leaving the U.S. behind in 2019 and extended its lead in 2020. China filed 68,720 applications while the U.S. filed 59,230. The rate of increase was higher for China with a 16.1% year-on-year increase versus 3% for the U.S. China first knocked the U.S. from the top spot in 2019. China’s R&D spending in total accounts for around 20 percent of the world’s total. Therefore, investing in China provides access to the leaders in technologies shaping the world of tomorrow.

(Source: https://www.cnbc.com/2019/11/22/china-drive-to-be-world-tech-leader-could-accelerate-as-its-economy-slows.html)

(How was that possible? Several factors are supporting this trend: With its 1.4 billion citizens, China has a huge domestic market that provides technology innovators plenty of room to grow to a critical size. China’s government has a strong willingness to support its growth engines and has the authority to shape industrial policy and provide infrastructure to achieve this. In addition, global projects like the belt and road initiative have opened many doors to gain market share in Asia and EMEA. In our view, these are very positive conditions to allow innovative business leaders to emerge and grow.)

https://www.reuters.com/article/us-un-patents-idUSKCN2AU0TM

https://www.cigionline.org/articles/what-do-chinas-high-patent-numbers-really-mean/#:~:text=China%20has%20led%20the%20world,total%20patent%20applications%20that%20year.

Since opening the economy for foreign trade in 1978, China has been very successful in boosting its exports as the main catalyst for its growth. This was a great success story, but it also has exposed China to the vulnerabilities inherent in international trade integration. Therefore, China's dual circulation strategy places now a greater focus on the domestic market, or internal circulation, in order to be less dependent on an increasingly less supportive world economy and foreign policies of other countries. As a main engine of this strategy, China has just entered its 14th Five Year Plan of targeted investments to support its domestic growth, aiming at increasing consumption to support China’s economic development.

The dual circulation strategy reflects China`s long-standing ambition to become more self-sufficient and involves developing its huge domestic market of 1.4 billion consumers as a main driver of growth, steadily increasing the share of the population belonging to the middle class with sufficient wealth to increase consumption. Since 2006, China managed to add an average of 60 million people to its middle class every year. To illustrate the magnitude of this growth, it is roughly the same as the number of people living in Italy. In relative terms, China is experiencing the fastest expansion of the middle class the world has ever seen. According to recent projections, about 1.2 billion Chinese people will be in the middle class by 2027, making up one quarter of the world total. This might further increase investor`s confidence in China`s economic strength and its ability to continue the growth story with a new catalyst.

https://www.mckinsey.com/~/media/mckinsey/featured%20insights/china/china%20still%20the%20worlds%20growth%20engine%20after%20covid%2019/mckinsey%20china%20consumer%20report%202021.pdf

For equity investors, another relevant factor for an investment decision is valuation and other indicators about future supply and demand of the respective stocks. In this regard, there are several promising facts investors should know:

In 2020, China’s share of global GDP was about 18%, while its share of global equity capitalization was only about 12%, even before the drop in 2021. Considering China’s significant growth, this doesn’t suggest that China’s equity market is overly expensive. In addition, equities appear under-owned by Chinese households (8%) vs. equity ownership in developed economies (US 25 percent). And China is currently also under-owned by foreign investors, as they hold just 3% of the broad market in China.

Further demand might come from investment strategies guided by market indices: The MSCI inclusion factor for Chinese equities should grow from the current 20 to 100 percent in 2026*. This alone could lead to inflows of up to USD 240 billion as a significant source of demand in equities. If you take these factors altogether, the perspectives for increasing demand in Chinese equities seem to be quite promising.

Many investors still perceive Chinese A-share stocks as a rather risky part of their overall portfolio. But as a building block of a well-diversified portfolio, they can even reduce the overall risk. This is because China’s A-Shares have a low correlation with international stock markets and high-return dispersion, which makes the asset class attractive to diversify the portfolio without diluting the average returns. In addition, the China A universe of stocks is a broad segment covering many industries and individual firms, hence offering broader diversification at an industry sector level than can be gained via the stocks listed in Hong Kong. It even offers access to unique sectors.