To get to his location in Beijing, a driver with the ride-sharing firm DiDi uses a map on his smartphone.
Getty Images/AFP/Nick Asfouri
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Investing in China is more difficult than normal these days, prompting some to question if it’s worth the effort. And it’s not expected to get much simpler in the immediate future, though volatility in the coming months may present opportunities for long-term investors. Chinese officials have been targeting the country’s largest and most popularly owned internet companies since canceling Ant Group’s scheduled public offering last year. Beijing retaliated on July 2 by conducting a cybersecurity review of the United States.
Global DiDi
(ticker: DIDI) and removing its app from app stores as part of a tightening of data security and standards for companies listed overseas.
The move, which came just days after DiDi raised $4.4 billion in the year’s largest IPO, caused the stock to plummet by a fifth of its value on July 6 and shook other Chinese internet stocks. The
CSI China Internet KraneShares
Investors are bracing for increased scrutiny of tech companies’ data practices and other regulatory initiatives, as the exchange-traded fund (KWEB) has dropped 15% since June 30. Gavekal Research’s head of research, Arthur Kroeber, said, “We now know this is a regulatory quagmire, and those that expose themselves to the industry are taking on a lot of volatility.” “If you have a long-term horizon, this will be one of the next decade’s growth stories, and you must ride it out. If you’re looking for something more immediate, you may argue it’s too complicated and return in a year when things have settled down.” The flurry of regulatory actions has created the kind of ambiguity that attracts bargain hunters. Technology behemoths such as
Alibaba Group Holding is a holding company owned by Alibaba.
(BABA), whose stock has dropped 11% this year, is catching the attention of value investors. However, caution is advised, particularly for investors in shares of Chinese companies listed on the New York Stock Exchange. Regulatory pressures may persist. Kenneth Zhou, a partner at Beijing law firm WilmerHale, says, “It’s probably just the beginning of the enforcement actions.” China’s regulatory push has been described by fund managers as a move to gain better control and put in place safeguards for fast-growing digital industries and internet behemoths. It’s also a way for Beijing to deal with rising US-China tensions, which are being exacerbated by recent legislation in Washington that sets the stage for Chinese companies to be delisted if they don’t provide more auditing disclosures within three years. One source of concern for Chinese regulators is the vast amounts of data collected by Chinese tech companies listed in the United States, which could pose a national security risk. In a recent research note, Rory Green, head of China and Asia research at TS Lombard, wrote, “Data control is turning up to be a major internal and geopolitical issue, with direct equity market consequences for corporations operating on both sides of the Pacific.”
Beijing is attempting to exert greater control over Chinese businesses, including those that are publicly traded. Alibaba, for example, is one of China’s top tech companies.
Tencent Holdings is a Chinese company.
(Hong Kong) (700.Hong Kong) (Hong Kong) (Hong Kong) (
JD.com
(JD) is a Cayman Islands-based company that uses a variable interest entity (VIE) structure to circumvent Chinese restrictions on foreign ownership. The complicated structure, which is generally ignored by investors, is a gray area since it prevents foreigners from owning an interest in a Chinese company. Instead, they must rely on China to keep promises made to the corporation. China has mostly ignored the extralegal system for decades, but it is suddenly paying more attention. According to Bloomberg News, Beijing is considering requiring companies that utilize this structure to seek approval from the Chinese government before listing elsewhere. Companies that have already been listed may need to get approval for any secondary offers. Analysts and money managers predict that China will not be able to erase the VIEs, which are employed by the country’s largest and most successful enterprises and would take decades to remove. Many others are also unconvinced that the US will follow through on its threat to delist the country. VIE inspection, on the other hand, might be used by Beijing to establish greater control over corporations and to push back against US authorities’ demands for more transparency. Indirectly, the scrutiny will likely bolster Beijing’s efforts to entice local companies to return home—a move that has already resulted in Alibaba’s secondary listing in Hong Kong.
Yum China Holdings is a Chinese food company.
(YUMC), as well as JD.com. Analysts predict that increased scrutiny will reduce, if not halt, the number of Chinese companies going public in the United States in the near future. It might also reduce the number of U.S.-listed Chinese businesses that appeal to do-it-yourself retail investors, which now stands at over 240 with a combined market value of over $2 trillion. According to Louis Lau, manager of the Brandes Emerging Markets Value fund, any of these that are unable to get secondary listings in Hong Kong or China may go private. Stocks listed in the United States may experience more volatility as a result. Whenever possible, fund managers and institutional investors, including Lau, have gravitated toward stocks listed in Hong Kong or mainland China. Mutual or exchange-traded funds are the greatest option for regular investors to have access to these overseas listings, as well as the more locally oriented stocks that certain fund managers like. Money managers are better equipped to deal with the logistical challenges posed by US-China tensions, such as the consequences from a recent executive order prohibiting US investment in enterprises with ties to China’s military complex, according to Washington. The S&P Dow Jones Indices and the FTSE Russell voted earlier this month to delist more than 20 Shanghai and Shenzhen-listed companies. Other corporations could be blacklisted, resulting in similar consequences, according to Reuters, which reported on July 9 that the Biden administration is considering adding more Chinese entities to the prohibited list due to alleged human rights violations in Xinjiang. As investing in China becomes more challenging, the rationale for choosing a fund manager who can traverse these intricacies and invest locally is becoming stronger. Failure to do so could cost you a lot of money. The
MSCI China A iShares
Over the last three months, the ETF (CNYA) has gained 3%, while the S&P 500 has gained 2%.
Golden Dragon Invesco China
In the same time period, the ETF (PGJ), which tracks Chinese companies listed in the United States, has lost 14% of its value. “Regulation is here to stay,” says the author. “Investors will just have to get used to it,” says Tiffany Hsiao, a portfolio manager for Artisan’s China Post-Venture strategy. “This is capitalism with a Chinese flavor. China is, without a doubt, still a communist country. It supports capitalism in order to spur innovation and increase production, but it is critical for successful businesses to pay back to society—as Chinese regulators will remind you.” As a result, she believes that investors should look outside the widely owned internet behemoths to locate equities that will gain from the increased regulatory scrutiny that the behemoths will be subjected to. Veteran investors are emphasizing selectivity, looking for companies that aren’t in the crossfire in local markets. “A company can have wonderful foundations and exciting potential but be blindsided by government intervention, which is becoming more active,” says David Semple, manager of the Center for Strategic and International Studies.
Emerging Markets VanEck
a fund (GBFAX). “Being involved necessitates a higher level of conviction than usual.” Semple is drawn to companies he knows, in industries that may be impacted by regulation, but not to the extent that investors believe. One example is China’s efforts to reduce child-care expenses and encourage families to have more children by targeting after-school course providers. Nonetheless, Semple sees potential in the situation.
Holdings of the China Education Group
(839.Hong Kong), which may make purchases as Beijing requires public universities to sell off their linked private colleges. Semple prefers Tencent, the top holding in his fund, to Alibaba, another holding, among the huge internet stocks. Tencent has an advantage over Alibaba because of its Weixin messaging and videogaming brands, which generate a high-quality, low-cost flow of users for its other businesses, according to Semple. According to Martin Lau, managing partner and portfolio manager at FSSA Investment Managers, which manages $37 billion, Tencent has quietly cooperated with the government’s regulations, with CEO Ma Huateng keeping a low profile. Given the reaction directed against Alibaba and Ant co-founder Jack Ma, this is a plus. The fundamentals of many Chinese internet enterprises are strong. According to Xiaohua Xu, a senior analyst at Eastspring Investments, complying with the tight rules on acquiring and securing user data will likely lower their revenues in that field. Alibaba and other internet companies, such as JD.com, are accessible to value investors. However, investors’ growth expectations are expected to be recalibrated as Beijing implements new laws and examines previous agreements, causing volatility. Furthermore, heavily held U.S.-listed Chinese stocks, such as Alibaba, could serve as proxies for investors’ concerns about China. Despite the red indicators, investors should keep China on their radar. “If you’re looking to purchase growth, the globe has two engines: the United States and China,” says Jason Hsu, chairman and chief investment officer of asset management Rayliant Global Asset Management./n
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