13 April, 2021 09:13

China has outlined in its latest five-year plan the three key pillars supporting its drive towards being a world power. These include technological advancement and boosts to both private investment and domestic consumption. But what will this mean for investors?

China’s technological advance will be crucial for growth but while investments in education and R&D have been impressive, NN Investment Partners (NN IP) sees the main risk lying in China’s relations with other countries, from which it still needs to import knowledge, capital goods and high-end components. The extent to which China’s business climate will be able to generate the required level of private-sector investments is also questionable given the central government’s reluctance to give up enough control for competition in the corporate sector to drive innovation to a higher level.

NN IP believes that of China’s three ambitions, the one most certain of success is likely to be consumption growth. The improvements China has made in social security and public services since the 1990s have laid much of the groundwork for households to save less and spend more, while a more active income policy and the gradual easing of restrictions for internal migration should help expand the middle-income group and drive urbanization.

NN IP believes that investors could benefit from focusing on consumption and services-driven stocks in the ‘new economy’ sectors of consumer staples, consumer discretionary, media & entertainment and healthcare. Additionally, investors should focus on IT companies, especially those that build digital and telecom infrastructure and those active in the broad shift from offline to online. Sectors to avoid are likely to be energy, materials and industrial stocks.

Many of the new economy companies are listed on the A-Shares market, which is becoming more accessible: China is opening its equity and bond markets to foreign investors to reduce dependence on domestic bank funding and make capital allocation more efficient, while boosting international use of the renminbi.

Maarten-Jan Bakkum, Senior Emerging Markets Strategist, NN Investment Partners: “The Chinese leadership’s ambition to double its economy in the coming 15 years should be taken seriously. Experience shows that China tends to meet its growth targets. But whereas China’s rapid development in the past decades was mainly driven by exports, public investments in infrastructure and a sharp increase in leverage, growth in the coming period will have to come primarily from innovation and the private sector.

“This strategy makes sense, given China’s high debt levels, the more challenging global environment and the clearly less favourable demographics picture. But if the private sector becomes the decisive force and capital allocation becomes increasingly market-driven, the authorities will not be as firmly in the driving seat as before. This should make China’s future growth trajectory less predictable and more volatile.”

Investors who approach China from a strategic angle would do well to consider allocating explicitly to A-shares. The China weight in EM has risen sharply in the past years to 39% currently. The dominance of China has become so large that more investors are likely to start allocating to China and EM ex-China separately. China is likely to continue growing relative to the rest of the emerging markets. As this is likely to be driven primarily by the higher growth and better accessibility of the A-share market, it is recommendable to position for this with a strategic overweight in A-shares alongside a neutral allocation to Chinese equities overall.