The Chinese Dragon

Over the past decade the Chinese dragon has been mercifully subdued, with only brief sightings, however when it decides to surface its wrath knows no bounds, as Tencent and the other gaming companies discovered in late 2018. In the past year, however, it appears that the dragon is on the loose with President Xi in the saddle, breathing fire on any company or person who dares to possess what is deemed to be too much wealth, or power over the minds of the Chinese population. Jack Ma and the technology giants were the first to face the full force of flames, however, in recent months the destruction has been more widespread.

Last week, President Xi, explained his actions as part of his efforts to promote ‘共同富裕’ or ‘common prosperity’. This policy includes addressing income distribution to expand the middle-income category and increase earnings for the low-income by ‘asking’ the rich to participate in charitable undertakings and return part of their accumulated wealth to promote social development.

Having recently seen the party centre ban education companies from making profits, in an effort to reduce the burden on households, which it sees as one of the barriers to why their relaxing of the one-child and the subsequent two-child rule has not worked, Chinese companies are paying close attention to the increased level of rhetoric coming from the Centre. On the day after Xi made his announcement it was notable that Tencent put aside RMB 50bn ($7.7bn) for a ‘common prosperity’ fund in addition to their similar size ‘sustainable social value innovation’ fund announced earlier this year. Similarly, the online retailer, Pinduoduo, who faced the wrath of the regulators in July, pledged RMB 10bn ($1.5bn) to the farming sector; a sum that is larger than the cumulative total profits that the company has made since floating in 2018.

This crackdown on technological innovation raises questions as to whether the Chinese entrepreneurial spirit will be more muted in the future. The policy of letting some of the population to ‘get rich first’ and then let the others catch up has seen China make huge the advances over the past decade, transforming from a country that was known to imitate the successful Silicon Valley companies to one of home-grown talent; the risk is that this momentum may stall.

Investors are, rightly, likely to remain concerned as to the investibility of China as a whole, as questions will linger as to which companies will be allowed to generate profits, and if they do, how much of these profits will be expected to be returned to the state rather than being distributed as shareholder returns. Certainly, the unpredictable nature of edicts coming from the centre has raised the stakes in investing in Chinese regulated firms.

While the dragon continues to circle overhead, Chinese equities will remain under pressure and their share prices are likely to remain more volatile, as they react to each edict from party central. For the more adventurous investor, it could be argued that value is appearing in some truly world-class businesses for the first time in many years, and the long-term prospects may be worth the short-term risk.

We always believe that a fund’s geographical distribution should be looked at by where companies generate their revenues and profits rather than country of listing. Therefore, if you are minded to believe, that, Chinese equities are no longer investible, there are plenty of multi-national companies that may even benefit from the changing political landscape.

The common prosperity announcement sent global luxury good companies reeling as China has been a key source of growth for them for many years, and an attack on overt prosperity is likely to mute this growth.

The alternative argument, however, is that the redistribution of wealth drive may increase the addressable market for these companies, as well as others, such as the cosmetic companies. The consumer discretionary market has been a large beneficiary from increasing disposable incomes in China. With an aim to increase the wealth of the middle-class, those who have aspired to own their goods or wear a particular brand may find these desires might slowly become less of an ambition and more of a reality. Similarly, the large infant formula companies such as Danone and Nestlé should find solace in the determination of the Communist Party to address the declining population problem.