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This week sees the G20 leaders gather in China and Theresa May’s first foray on the world stage as the UK’s Prime Minister. These events coincide with the 40th anniversary of the death of Mao Zedong, the founding father of the People’s Republic of China. In the intervening decades, China has undergone an unprecedented period of economic transformation, set in motion by the reforms of Mao’s successor Deng Xiaoping.  This resurgence is all the more remarkable given the economic and social chaos that characterised Mao’s years in power.

As we look ahead to the next 40 years, and weigh up the various investment opportunities, it is essential to appreciate China’s revival within its historical context.

 

Looking to the past

A common misconception is that China’s recent rise to prominence is a new phenomenon.

Writing back in 1776, Adam Smith, who lends his name to Adam & Company, noted that “China has long been one of the richest, most fertile, best cultivated, most industrious and most populous countries in the world.” 

Renowned British economist Angus Maddison, writing 200 years after Smith, agreed with these observations. Maddison estimated that China’s share of global GDP has ranged from around a quarter at the beginning of the first millennium to as much as a third by 1820.

With this in mind, China’s rise since the 1970s is best interpreted as a return to the status quo of the past 2000 years.

“China has long been one of the richest, most fertile, best cultivated, most industrious and most populous countries in the world.” 

Adam Smith (1776)

Looking to the future

Despite population and GDP growth stagnating, there are still plenty of reasons to remain bullish on China’s future prospects.

China’s population is becoming increasingly educated. Chinese schools are ranked number one globally for both reading and maths according to the OECD, while Chinese universities graduate more than 1.2 million engineers a year and nearly 30,000 PhDs in science and engineering.

Chinese companies, often with substantial state support, are making significant investment into pioneering technologies. Research by McKinsey & Co has shown that China leads the world in the number of patent applications filed and that Chinese companies now spend close to $200bn annually on Research & Development, second only to the USA.

China’s urbanisation, and the growth in consumer wealth that accompanies it, is showing no signs of coming to an end. China’s cities have added the equivalent of the USA and three United Kingdoms to their populations over the past 30 years and are expected to be home to over 1 billion people by 2030. The spending power of this swelling urban middle class will be a key driver behind China’s transition towards a domestic consumer-led economy.

As China becomes ever more educated, inventive, and wealthy, what are the opportunities for investors?

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The challenges of investing in China

Although it is fairly straightforward to identify the potential of the Chinese economy, it is far more challenging to unearth viable and accessible investment opportunities.

This conundrum for investors is well illustrated by the case of Barton Briggs - Morgan Stanley’s former chief market strategist who successfully predicted the stock market crash of October 1987. After returning from a trip to China in 1993, Mr Briggs published a note titled ‘China!’ in which he enthusiastically envisaged “the mother of all bull markets”.  Two months later, Mr Briggs conceded to his clients that identifying the winners and losers of the Chinese economic miracle was not as simple as he had initially anticipated – Morgan Stanley reduced their exposure to China by a third overnight.

Anthony Bolton, the veteran investor, tried to apply his investment principles that had delivered stellar success for Fidelity’s Special Situations Fund for 28 years, to the Chinese market. On his retirement in 2012, he said: “The most disappointing thing for me – and I am happy to admit it – is that I was wrong about the market in China.”

 

HOW WE SEEK TO INVEST IN CHINA

Our exposure to the market is through direct investment in companies that sell into China, in areas as diverse as whisky, car engines, and porcine semen. Successful companies often start slowly and build share over time, frequently through joint ventures.

Intellectual Property has to be closely guarded – companies such as Genus do not allow breeding of their genetically refined pigs, and will only sell porcine semen directly to the pork producers. The pork market is enormous in China and Genus’s pigs are tailored to provide the thicker layers of fat demanded by Chinese consumers. CEO Karim Bitar estimates that the Chinese consumer spends around 30-40% of their disposable income on food – which is clearly a lucrative market for Genus to address.

While China is driving to encourage domestic consumption growth, of course other Far Eastern economies trade substantially with her, so it is worth looking for good companies that have exposure to the region as a whole. We own funds run by managers who take the same long-term approach as we do, and aim to identify companies that are well run, with strong balance sheets and attractive valuations. Some funds also invest in income stocks and the yield can be attractive, particularly given low interest rates globally.

 

POLITICAL RISK NOT CONFINED TO EMERGING MARKETS

China article

The Chinese stock market boom and bust that we witnessed in the last two years was a timely reminder of the risks involved with investing in Chinese companies, particularly when liquidity is squeezed. Despite this, we cannot afford to simply ignore China’s growing global influence, not only as a growth powerhouse, but also as an investor overseas, in resource-rich Africa and Latin America, as well as in the UK. This week in Hangzhou, the Prime Minister will be seeking to reiterate the UK’s stance as being a friend of China, despite ongoing uncertainty over Hinkley Point.

Politically there are risks, although given the Brexit vote, US presidential elections, and German and French polls in 2017, it cannot be said that that risk is purely a phenomenon of emerging markets.

China is set to overtake the US as the largest economy in the world, yet we in the West remain largely ignorant of much of its history and culture. Unless companies, and politicians, actively seek to address this failing, we cannot expect to benefit from the great opportunities that China will present over the next 40 years.

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