Elaine Tse, Portfolio Manager with the Global Emerging Markets Equity team at Wells Fargo Asset Management discusses navigating China’s A-shares for investors.
Laurie King: I’m Laurie King, and you are listening to On the Trading Desk®. In part two of this mini-series on China’s A-shares, we hear how Elaine Tse, portfolio manager with the Global Emerging Markets Equity team at Wells Fargo Asset Management, is navigating this new opportunity for investors. Also returning is Matt Alexander, thought leadership manager covering Elaine’s team. Matt, welcome back.
Matt: Thanks for having me back.
Laurie: A quick couple program notes: One, listen to part 1 of this series if you haven’t already. Elaine Tse plainly explains what A-shares mean for investors. And secondly, contact your Wells Fargo Asset Management relationship manager for Elaine Tse’s full Market Insights paper. But today Matt, considering all the new A-shares accessible to investors in China—I imagine that must translate to being tremendously selective?
Matt: Yes. And, in fact, that is something that Elaine and I did talk about. And there certainly are pitfalls and opportunities. And that certainly creates a need to be selective.
Laurie: Well, let’s listen.
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Matt: Well, Elaine, thanks for continuing this conversation with us.
Elaine Tse: Sure, anytime Matt.
Matt: In your Market Insights paper, you called China’s A-shares, “The active opportunity.” Why emphasize active and not passive?
Elaine: Well, with nearly 30 years of experience investing in emerging markets, I cannot emphasize enough how important active management is in these markets. There’s such a wide disparity in the quality and the prospects of the companies, it’s so important to be on the ground to be able to meet management, to be able to assess the financial conditions, and to consider the future of the individual businesses. The sector outlooks and cycles in China, in particular, are very dependent and sensitive to government policies. So to be able to distinguish between the winners and losers within a sector really requires deeper fundamental analysis than the passive approach.
So just as a simple example—top-down—we can say we like A-shares. Currently, valuations are attractive at around 12 to 13 times forward earnings, and earnings growth will be pacing mid-teen per annum for the next two years. Now A-shares have a large financial sector weight compared to its off-shore counterpart because there are many listed joint stock banks, city and rural commercial banks as well. We would be hesitant to invest in many of these banks given concerns over asset quality, especially as the government cracks down on shadow-banking activity. But a passive approach would, in fact, give investors quite a bit of exposure to this area.
Matt: So, generally speaking, does an A-share company look any different to you in terms of quality or risk, compared to other share classes?
Elaine: I can’t really say that A-share companies look different as a group. As with H-shares, there are strong companies and weak companies, there are expensive companies and cheap companies.
Perhaps what we have been able to find in A-shares that we did not get in H-shares, especially for the consumer space, is the brand leader with the highest market share, the best pricing power, and the highest margins. Sometimes an attractive industry or subsector is only available in A-shares. For instance, high-end liquor companies and leading home appliance manufacturers, and that’s also the case for some specialty electronics that are only listed in A-shares.
Matt: So with the mass adoption of A-shares, how does this really elevate the economy and the business environment as a whole?
Elaine: I suspect that as China moves up the value chain and leapfrogs in technology, many of these high-growth companies increasingly choose to list in the A-share market, either based on government directive, or national pride, or simply because they feel that the domestic investors are most familiar with their brand or business model and their growth prospects.
One recent example is a leading electric vehicle battery maker who chose to list domestically instead of overseas. I expect the IPO of the next generation of leading Chinese companies to be in A-shares, and that’s why it’s important for us to be in this market.
Matt: So Elaine, that’s very interesting. Do you have any parting thoughts or crucial takeaways for investors regarding A-shares in China?
Elaine: I would just reiterate that the A-share market is probably one of the most attractive growth opportunities globally. It’s also a market that’s highly sensitive to domestic liquidity conditions and changes to government policies. So it is important to have a deep understanding of the political and macro environment and the regulatory framework. But also remind investors that the A-share market at this point is still one that is dominated by retail investors which means that the herd or momentum mentalities can sometimes bring greater volatility, and valuations often overshoot on both upside and the downside. So, it’s a market where fundamental analysis is even more important to maintain conviction in your investments.
Matt: Elaine, on behalf Laurie and our listeners, thank you for joining us.
Elaine: Great, thanks.
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Laurie: Matt, as I was listening, one key takeaway I found intriguing was that the A-shares, they really encompass so many more of the leading companies within China. And Elaine gave a number of examples. I was amazed that there were so many leader companies only available in A-shares.
Matt: Yeah, it is interesting that there are so many leading companies that are kind of pioneering in their space. In the paper Elaine talked about the “backbone” of the internet, some of the smaller players that are making the larger players we hear about, like Alibaba or Tencent, successful by building the backbone of the internet and infrastructure, and some of these companies are only available as A-shares, yet, they are leaders in their space.
Laurie: Well, and the other thing the paper talked about was how there is so much competition between these companies to get to the top and be the best that it’s really sparking innovation. And then you get to the leap-frogging effect that it’s just amazing how innovation in China is advancing at a really fast pace because of this incredible competition.
Matt: Yes, and I think a lot of it has to do with the scale of the investment in that space. You have multiple competitors that are trying to compete, and it forces them to innovate.
Laurie: Well let’s wrap up this two-part conversation Matt. I’ll remind our audience to stay informed by visiting our blog AdvantageVoice®. But Matt, thank you, and we look forward to hearing from you again.
Matt: Thank you, Laurie.
Laurie: Until next time, I’m Laurie King. Take care.
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All investing involves risks, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors, some of which may be unpredictable. Each asset class has its own risk and return characteristics. Foreign investments are especially volatile and can rise or fall dramatically due to differences in the political and economic conditions of the host country. These risks are generally intensified in emerging markets.