Exercise caution when investing in China


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SIMON BROWN: I’m chatting now with Kyle Wales, portfolio manager at Flagship Asset Management. Kyle, I appreciate the early morning time. We are talking of China. Lots of people are loving China because the equity market’s done well. We’ve seen it in Hong Kong, we’ve seen it in China-related stocks. We’ve seen it in Tencent which has of course flown into our market (via Naspers and Prosus). You make a couple of points, kicking off with yes, we’ve had that strong period as we move away from the zero-Covid policy. But let’s be clear, that policy was an absolute mess at huge cost to personal freedoms and, more recently, in the last couple of weeks and months, to human life.

KYLE WALES: Absolutely, Simon. While we’ve obviously moved away from zero-Covid – and that’s a very positive development – a lot has happened in China in recent years, which in my view makes it a far more risky proposition than it was before this. I can draw on, on a number of things.

One was obviously – and most of you will remember this – Jack Ma, the founder of Alibaba, making a statement that was critical of the regulators. He was forced to flee China. Alibaba itself was forced to abandon its plans to list Ant, its financial subsidiary in New York, causing an enormous amount of financial damage to investors. That stock in particular fell 60% over the following months.

When we think about China, obviously we are seeing a lot of positive news come out of the country now but, from a longer-term investment perspective we just need to take into account the geopolitical risk.

SIMON BROWN: You mentioned Ant, and there was the destruction of the private education. There was Didi which listed, and then a week later wasn’t allowed to onboard new users. That has just recently been lifted. Now they can. It was the way they did regulation. Sure, regulation’s fine, but it was just ham-fisted as an outsider, and you never knew where the next one was going to come from.

KYLE WALES: Yes. I think with a lot of these companies the management teams made mistakes and misread the regulatory environment. But most of these businesses are listed in New York. Their primary listings are in New York, so it’s actually more the foreign investors that suffered as a result of this. It’s very unfortunate that that regulation or the negative effects of regulation were targeted at foreign investors who placed their confidence in China.

SIMON BROWN: Yes. You mentioned geopolitics. In an ideal world we would invest without worrying about politics. But that seldom exists. But certainly Xi Jinping got his third term, very much ruling with an iron fist almost in the sense of the olden days of dictators – or, as you [said], we can almost draw parallels between Russia and Turkey and their respective leaders.


In the past people have always taken a sort of easy view of the fact that China is actually a dictatorship of sorts, because their policies were so business-friendly. But the reality is that that can change overnight.

In Russia [it was] the same thing with Putin. People were very sanguine about the risk to business in that country, even though political freedoms were obviously curtailed there. But as soon as the Ukrainian invasion happened, the game changed for everyone. It’s just useful to bear in mind that those tail risks are definitely there when power is concentrated in the hands of a single individual.

SIMON BROWN: And we’re already seeing some response. You make the point in the note you wrote that Apple is moving manufacturing from Vietnam to India. Some of it is India saying, ‘We want you to produce in our country if you’re going to sell in our country’. But certainly the days of Foxconn manufacturing all of Apple in China are over. We are seeing the caution already.

KYLE WALES: Yes, absolutely. It’s not necessarily a good thing for consumers. It will perhaps lead to higher prices just because supply chains have become a lot more complex. But the reality is when China was closed during zero-covid, Western multinationals had to make alternative plans and they were made aware that they couldn’t rely solely on a single source for many of the components and final products they needed. And that businesses moved away. In my view it is never going to return to China, because the risk will always be top of mind for many of these businesses.

SIMON BROWN: Yes. When we say markets have memories, so do CEOs and COOs. We’ve also still got some trade wars happening. It started under Trump. Biden hasn’t done away with it, although [that] he doesn’t do it via Twitter is perhaps the big point. But it’s particularly in the tech space. That is also going to hinder China. The ability to sell advanced technologies to Chinese companies has been quite severely curtailed.

KYLE WALES: Yes. But the Chinese walls in the tech sector were also [put up] simply so the Chinese Communist Party could maintain control of the information that was disseminated to ordinary Chinese people. As a dictatorship, key for them is actually keeping the population happening and keeping themselves entrenched in power.

But, yes, in terms of China’s relationship with the West, obviously that’s gone from bad to worse. And while the West is partly to blame – and by the West I’m specifically targeting part of the US – China has made a couple of bad decisions itself. Taking the position of Russia in this Russia-Ukraine conflict, certainly when Western public opinion is very much in favour of Ukraine, was also not a friendly move, and one where I certainly don’t see substantial benefits in taking that position for the Chinese. So it doesn’t look like that relationship is going to improve anytime soon, and I think it’s to the detriment of both parties.

SIMON BROWN: The short answer then to wrap it up is that investors should be looking to actually allocate less to China. It’s difficult, particularly as a South African investor with Naspers/Prosus/Tencent, to have a smaller allocation to China, to be careful not to get sucked in by the great numbers that we have seen from, from their indices over the last couple of weeks and months.

KYLE WALES: Yes. I think it’s always useful to remember that past returns are not indicative of future returns.

So recent outperformance in Chinese markets shouldn’t be extrapolated. And from a portfolio perspective I think it’s always prudent to have a globally diversified portfolio.

…I’ve mentioned it a couple of times in different forums: South Africa is 0.5% of global GDP [and] most South Africans are overly exposed [in China]. But China similarly, within the various stock indexes globally also makes a surprisingly small number. So it doesn’t make sense to have too much exposure to Chinese stocks.

SIMON BROWN: We’ll leave it there. Kyle Wales, portfolio manager at Flagship Asset Management, I really appreciate the insights this morning.

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