China’s Regulatory Announcements Part II

Q&A with CIO Robert Horrocks, PhD: Understanding the context and implications for long-term investment opportunities in China.

Has the recent flurry of regulatory changes changed the case for the long-term investment opportunities in China?

No, it hasn't changed my view on the absolute investment case for China, nor indeed the relative case, which I still think looks very good. It's been obvious that China has been very focused for many years on the welfare of consumers and the welfare of the worker. I think it was in response to a worldwide phenomenon where workers were losing ground to capitalists across the world. China decided it was going to do something about that—the so-called "move to stability" in the Chinese economy. The current mantra is not stability as much as it is quality. How can you get returns on capital up so that you can generate higher rates of growth with less investment? That's the main focus. That's the focus because they want to see people's standards of living continue to rise in a way that will keep them happy with what the Communist Party is providing.

Are the issues around social justice becoming increasingly important in China?

Yes, but I don't think that's unique to China. Social justice, environmental considerations, governance and good management of companies—taking all of these things into consideration when you make your investments is very, very important. But I still believe that China is ahead of the West in terms of taking on some of these issues, in terms of the way that it's dealing with some of its internet businesses. 

How would you characterize the view of portfolio managers across the Matthews Asia investment team in regards to China and the market regionally?

We will always have varied views across the investment team. I would say that the most common shared view is that they're looking at things in a slightly different perspective than maybe your average U.S. investor is looking at them. I think the team is a lot more comfortable with the idea of regulation and how China goes about it. And perhaps, we haven't done a good enough job of explaining the regulatory environment in China. That being said, there are numerous examples of sectors having been regulated in the past. I think we're pretty confident in the view that there has been an overreaction, but it's been exacerbated by a lack of communication by the Chinese side, and maybe a lack of knowledge amongst some foreign investors. 

Can you share an example of a sector that was regulated in the past?

We had some instances in the health care sector, particularly as it pertained to pricing devices and drugs across the board. This was more about trying to broaden access to health care in China, and so there was a hit on the pricing that happened almost immediately. The payoff of that down the line though, is it increased volumes, and we're now starting to see that come through. And although, probably, a year or two later it hasn't totally offset the hit on pricing, I think overall it will do it in the coming years. So the market tends to anticipate these things, so even things that have an effect of up to 12 months are probably dealt with in the market much more quickly than that. So I do think that in certain parts of the market, you're already seeing good valuations now that price these companies appropriately. 

What about the online sector?

We certainly have had it in the online sector, particularly in the gaming industry where there was worries about the social impact of kids spending too much time in darkened rooms playing fantasy games, basically. The companies agreed with the self-regulation that they had to do, and then bounced back pretty strongly. So that was over in a matter of months and these companies still have their dominant positions in the market. 

China was the worst performing major emerging market in July—how long do you expect this negative sentiment to last?   

July is a tax month and there's a bit of a liquidity squeeze in the markets every end of July, and so that might've meant that this latest regulatory announcement came at exactly the wrong time. So it made the Chinese market temporarily more vulnerable to bad news and part of the market’s reaction has been somewhat extreme. People are trying to raise money to pay taxes (bond yields spiked too), to run the factories at two to three times their normal pace to build stock for the global economy, partly because rumors were coming out in the Chinese markets that the U.S. was about to do something to target Chinese companies on trade. So in that sense, that part of it, I think, is pretty much over and we've seen some particular securities bounce back very strongly already, so for some it's over.

In terms of impact of the regulation itself, I think it really depends on the sort of regulation, whether it's designed to take the private sector out of that particular market altogether, or whether it's just to have a better function in markets. And there I think it's normally just a period of weeks or months for companies to get used to this. 

What sectors, other than those that have been named already—technology and education—could be at risk to regulation?

Another area that the Chinese are focused on is real assets. Property is a big part of the Chinese economy, but what they're really concerned about in that space is that they don't want to develop a situation where real assets are used for speculative purposes. This doesn't have any bearing on property developers that are conducting themselves in a sensible way. It doesn't have a bearing on property management companies in that sense. But speculative activities around real assets I think is one area being looked at. It's not a huge part of the market, but it's something to be mindful of. Is regulation itself one of the big issues that I have about the China market? It really isn't in the sense that I think I can appropriately price it, and if anything, the market is already more than appropriately priced in those areas where I think government wants to work with private enterprise. 

As active investors, how do you monitor/mitigate regulatory risks?

Whenever you go into any investment in any country, not just China, you want to take account of the regulatory environment. It's not just a risk— often it can be an opportunity as well. So we do take that into account. I think that if you look today, a lot of Asian companies and Chinese companies, in particular, are trading on a substantial discount, given investors’ concerns with the recent regulation announcements. But the main thing to look at is the quality of the company—this is not something where on every piece of regulation the government is looking to slap down private enterprise. In our view it’s the opposite, it is looking to work in tandem with private enterprise. They know that private enterprise will, in most cases, deliver the best solution, they just want to guide them.

Where are the markets now?

If you'd look at where some of the well-known Chinese stocks are in terms of pricing, they're at 20% to 30% discounts on price-to-earnings ratios to global peers. They are in market-cap terms, relative to their peers, anywhere between one-third and one-tenth the size. And whilst they may not have the same opportunities to monetize, they certainly have opportunities to grow in what is a healthy and profitable environment. So I would say for a lot of these companies, we're already there. I do think the market is getting more discriminating though, for example in companies with weaker business models, where stock prices sort of rose together and then fell down together—I think some of the weaker business models will be shaken out. And so I don't think it's a case that you can blindly move back into some of these stocks.

Is this a buying opportunity?

The way I would look at it is this, when you get regulation into a market, part of it is cost and part of it is opportunity. The opportunity is the Chinese want a small number of large enterprises to help them control what they might see as inappropriate outcomes from pure market competition. So there is a sense in which regulated companies enjoy a little bit of a competitive moat. The quid pro quo for that is that you don't get to enjoy monopolistic profits. And so whilst a company might have a very strong position, its products should be priced appropriately for what a consumer would get in a normal, more competitive environment.

Where does China and Asia go more broadly?

In politics and volatility in markets and asset prices, I suspect we will gradually settle into a more normal rhythm. Market returns and swings between styles may be less aggressive. I don't think we should expect regulatory advances to just stop—the Chinese have been very active and will continue to be active on the regulatory front. And also one of the things that the Chinese government and other Asian governments have been far more cognizant of, compared to their Western peers, is the impact on the consumer, the impact on labor and labor’s share of the economy. So a lot of what China was doing is just what the rest of the world is thinking about but hasn't gone around to implement. But I do think you'll continue to see the Chinese government as being, on the one hand, both the champion of the consumer, but also a supporter of private enterprise. And that is the best growth engine they have. So, we remain excited at the prospects for our investments and are focused on finding the businesses and management that can best navigate the obstacles while taking advantage of the opportunities.


Investing in Chinese securities involve risks. Heightened risks related to the regulatory environment and the potential actions by the Chinese government could negatively impact performance.

All investments involve risk. Past performance is no guarantee of future results. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation.




The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in small- and mid-size companies is more risky and volatile than investing in large companies as they may be more volatile and less liquid than larger companies. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.