China: Portfolio management in the year of the pig

Feb 12th, 2019 | By | Category: Equities

By Chanchal Samadder, Head of Equity ETFs at Lyxor Asset Management.

Lyxor China ETFs

China: Portfolio management in the year of the pig.

It’s the year of the pig in China which marks the end of the 12-year cycle of the animals of Chinese astrology. As such, it’s a perfect time to look back, learn from the past, and prepare for the new cycle.

Leaving 2018 behind

There’s no doubt 2018 was a challenging year in China, as policymakers wrestled with the country’s debt issues, and tariffs and the trade war took their toll. Corporate defaults mounted, shadow banking was targeted, and credit growth contracted.

To alleviate the burden on a private sector suddenly bereft of liquidity, officials designed specific tax-cutting polices rather than resort to a re-run of the large infrastructure plans seen in 2008 and 2015. The damage done by the trade tensions materialized in the latter part of the year as trade figures dropped and housing investment soured.

For all that, the Chinese market is still young, and while there’s not much history on which to base a strategic view, there are plenty of reasons to be constructive on the country’s assets from a tactical, shorter-term perspective.

Controlling a slowdown

Why is it that China’s economic growth could well slow further in H1? It’s not down to trade even though the prospects of a temporary deal – or an extended truce – look greater. Finding a lasting resolution will be challenging given the inescapable long-term rivalry between the US and China.

Instead, the attraction is driven by policy. Growth should stabilize in H2 because there is more help on the way. We expect the People’s Bank of China (PBOC) to lower interbank lending rates and make further cuts to banks’ reserve requirements which should free up more money for new lending to the private sector.

China is also sticking with the large-scale tax cut strategy first deployed last year. The tax reduction programme for this year is set to be announced in March and could top 1.5 trillion yuan. The government has also outlined more tax breaks for small- and mid-sized businesses.

Chinese Credit growth suggests a stabilisation in activity

Source: Lyxor.

Source: Lyxor.

The problems are priced in

The market may not be at the distressed levels of end-2008, but things are still pretty ugly, and Chinese equities remain well below their long-term averages. Equity valuations have in fact reverted to 2014 levels, and many domestic Chinese firms have taken the hit already and issued profit warnings.

On the listed market, earnings expectations are for low double-digit growth for both onshore and offshore markets – 13.6% and 12.0% respectively for the MSCI China and the Shanghai composite indices. We don’t, however, expect a deterioration from here. We suspect the worst has been priced-in and that targeted stimulus (tax relief, relaxing regulations for margin trading) has put a floor under earnings downgrades.

China is too big to ignore…

The size of the China market means even more than its potential weighting in global indices. Inflows from non-residents recovered further to almost return to their long-term upward trend in 2018, thanks to a rebound in external banking debt and strong portfolio inflows facilitated by the fast-track opening-up of domestic capital markets. In fact, China attracted $50bn of equity inflows and $103bn of bond inflows in the first three quarters of last year, in the process surpassing full-year figures for 2017 despite a slowing economy and a depreciating currency.

Fast-track capital market liberalization was the crucial ingredient. Portfolio inflows are likely to stay strong again this year, especially with MSCI likely to quadruple the inclusion ratio of China’s A shares in their bellwether emerging market benchmark, the MSCI Emerging Markets Index. All told, China A shares should account for around 15% of the index. Meanwhile, FTSE will include China in its EM indices for the first time. This should help fuel portfolio investments for a few more years yet.

MSCI’s actions could be a substantial support for A-Share performance
On 31 May 2018, 233 China A Large Cap shares were added to the MSCI Emerging market Index using a two-step inclusion process

Source: Lyxor.

Source: Lyxor.



– The underlying MSCI China Index captures large- and
mid-cap exposure across China A shares, H shares,
B shares, Red chips, P chips, and foreign listings.

– Indirect replication through the use of swaps.

– Listed on London Stock Exchange in USD (Ticker: LCCN LN)

– Houses $70m in AUM and comes with a TER of 0.30%.

…and too disruptive to dismiss

China has become unavoidable for investors wanting exposure to the world’s new tech titans. According to the 2018 Kleiner Perkins Internet Trend report, nine of the top 20 internet companies in the world (by market valuation) are Chinese. On the listed market, China technology stocks have a weighting in global indices that is twice as high as Japan and European technology sectors combined. China tech stocks have even become bigger than Korea, Taiwan, and India combined (based on MSCI data).

In our view, if you want to capture the opportunities on offer, there’s no better index than the MSCI China.

If, like us, you believe this index represents the truest and best reflection of China’s economy, why not consider investing in our ETF? With a TER of just 0.30%, it is the cheapest Chinese equity ETF your money can buy.

Chinese astrology suggests those born in previous years of the pig are diligent, compassionate, and generous. They set goals and devote all their energy to achieving them. Calm when facing trouble, these “Pigs” handle things with care. They take responsibility to finish what they are engaged in. They are due some luck with their investments in 2019. Perhaps, if you adhere to those traits, you can expect the same!

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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