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I first visited China in 2004 on a trip to meet the major banks coming to the Hong Kong stock market in 2006. Along with representatives of the government and central bank, they went out of their way to reassure us they would protect foreign investors’ rights.
These Chinese banks had a reputation for running up bad debts, often from funding financially unviable initiatives aligned with the Communist Party’s social policies. But when we met them they had received serious cash injections to clear the slate and make the shares more appealing to investors.
I also remember a meeting with a big steel company whose two razor-sharp female senior executives theatrically rolled out a Chinese scroll. It was a 50-year timeline on which were marked the dates when various overseas steel mills would no longer be able to compete with China’s lower costs of production. Brutal!
At times in the past 17 years my global equity portfolios have had as much as 10 per cent exposure to Chinese shares, principally those listed in Hong Kong and in particular the fast-growing internet companies, Alibaba, Tencent and JD.com.
But earlier this year we sold all but one of our Chinese holdings. Over the years we have divested whenever we felt shareholders’ rights were under threat.
In 2015, for instance, we sold our holding in China Mobile. Despite the number of subscribers hitting 1.3bn and each of them using smartphones for more services, returns to shareholders were not increasing. Indeed, Beijing seemed either to be requiring the company to carry out unprofitable public works or subsidising its rivals to take market share.
We had also invested in Beijing Airport. This was so successful that the Beijing authorities built another airport at Daxing on the other side of the city — and then the regulator began telling many airlines to leave the old airport and use the new one. We disembarked from that holding in 2019.
More recently our concerns were raised by the cancellation of the Ant Financial listing in November 2020, the subsequent disappearance of founder Jack Ma for some months and ensuing regulatory action against many of the Chinese internet success stories. Occurring against a background of more assertive political rhetoric around Hong Kong and the South China Sea, all this made us uneasy.
Intervention has not ended there. At the beginning of July Beijing objected to the flotation in the US of Didi Global, the ride-hailing app, which led to the shares almost halving from their IPO price — a fall in value of about $36bn.
Beijing announced on July 23 that all quoted education services companies would be expected to be not-for-profit in future. Leading stocks such as TAL Education fell by 75 per cent.
In some ways China’s moves are laudable. They want drivers for ride-hailing apps to have rights, shopping sites to be open to payment choice, kids not to spend too long gaming or being over-tutored, and web businesses to benefit society generally, rather than just enrich a few. Some in the Biden administration might envy Beijing’s power to address these issues. But these actions demonstrate that shareholders’ rights are not a priority.
There are occasions when you cannot ignore political risk. You may look foolish walking away from a company, sector or a region for a while, but you have plenty of alternative options if you have the whole world to invest in.
We now have less than 1 per cent in China — with a remaining holding in the country’s leading wind farm company, which is still performing well.
In the past year capitalisations of many of the companies we had held have collapsed, while equity markets elsewhere have been rising rapidly. In US dollars over the past six months Alibaba has lost $217bn of equity value, Tencent $300bn, JD.com $44bn and Meituan $135bn — nearly $700bn between them.
Shareholders have revolted. What happens if this escalates? China’s speedy recovery from Covid saw a 62 per cent increase in overseas holdings of local stock year on year in 2020, to 3.4tn renminbi (around £380bn). But tides can turn quickly.
Those who have studied the Asian crisis of the late 1990s will see uncomfortable parallels.
The Chinese economic miracle of the past 30 years has been supported by a nation that saves a lot of what it earns, and has a trade surplus from the country’s exports and incoming foreign investment. The government also has a fixed exchange rate, which US politicians frequently complain is kept artificially low to boost exports — a form of subsidy.
The Asian financial crisis in the late-1990s saw countries with fixed exchange rates react slowly to capital inflows turning to capital flight. To try to stem the flow, interest rates were raised, which plunged domestic economies into crisis.
Three groups find themselves with more exposure to China than normal, even considering this is now the world’s second-largest economy.
Many technology investors have followed through their successes in owning Amazon and Uber by adding Alibaba and Didi Global to their portfolios.
Value fund managers have been attracted by the very low price/earnings ratios and price-to-book values of local industrial groups.
Most significantly, emerging market funds are now pressed to invest heavily in China, which now makes up 37.5 per cent of the MSCI Emerging Markets index. I fear this will become apparent to many private investors only after such funds have fallen sharply.
Much of the collapse of Asian economies in the late 1990s came from an unwinding of debt funding — many Asian companies had financed growth by borrowing US dollars but were earning their profits in local currencies — another reason that the removal of exchange control was resisted.
Most faster-growing companies in China seem to be funded through equity, but the contribution of late-stage venture capital from financiers overseas may be less stable than it seems. If they have used short-term debt to finance their stakes, expecting a quick profit on IPO, they face disappointment. This route is now either closed or offers a fraction of the valuation previously expected.
China still has huge trade surpluses to smooth adverse capital flows; recent events may cause just a temporary tremor in the markets. But we should not discount the idea of many more foreign shareholders unwinding their positions and the ripples extending beyond equity markets and beyond China.
It has taken China decades to stimulate homegrown entrepreneurship. Undermining the most successful businesses so publicly will have a rapid and lasting impact across the economy.
Nearly two decades ago, when I first visited China, the government was keen to demonstrate its care for shareholders and their rights. It is deeply troubling if that policy is being abandoned. As the Asian crisis demonstrated, it takes years to win back investors’ confidence.
Simon Edelsten is co-manager of the Mid Wynd Investment Trust and Artemis Global Select Fund