China A Shares Volatility / Opportunities
Reform in China
Since initiating market reforms in 1978, China has shifted from a centrally planned to a market based economy and experienced rapid economic and social development with real GDP growth averaging around 10% a year1. China has a population of approximately 1.3 billion and recently became the world’s second largest economy2. China is increasingly playing an important and influential role in the global economy. Notwithstanding this tremendous progress China is still developing socially and in respect of its market reform.
China A Share rally and the Correction
Sentiment and a retail-driven rally got out of control in late 2Q15. Mainland investors borrowed extensively seeking further gains in the markets and investors piled into A shares at an unprecedented pace. The economy, meanwhile, had fallen to 6 year lows in April3. This juxtaposition between the booming A share market and slowing economy was followed by an inevitable reconciliation. Chinese stock markets dropped around 40% since mid-June4 on concerns over the slowing economy. The volatility culminated on 24 August where the sell-off began in Asia with the Shanghai composite losing about 8.5%, the US stock market suffered its biggest sell-off in four years, almost £74bn was wiped off the value of the FTSE 100 and European stock markets suffered their worst days trading since 20115.
Significant policy adjustments seem necessary for China to sustain growth. Transitioning from middle-income to high-income status can be more difficult than moving up from low to middle income. China’s Five-Year Plan (2011-2015) highlights the development of services and measures to address environmental and social imbalances, setting targets to reduce pollution, to increase energy efficiency, to improve access to education and healthcare and to expand social protection.
Continued economic growth relies on continued economic restructuring. Growth may be compromised by bureaucratic interventions and such interventions may present an obstacle to efficient capital markets. China requires more efficient and developed capital markets to continue it reform trajectory. Economic advancement over the long term will be fostered by materially re-structuring inefficient state enterprises and inefficient capital markets.
Much of the recent move in A shares was driven by valuations rising and not by increased earnings expectations. Volatility remains a threat and investors should not expect another period of straight line gains but with selective allocations there may be opportunities still to be found in Chinese equities.
Ireland – Bridging the gap to China
In October 2014 Irish Funds signed a Memorandum of Understanding with the Asset Management Association of China which aims to facilitate enhanced / improved industry communications, information sharing, and reciprocal relationships and covers areas such as regulatory developments and sound practices to improve investor protection. The agreement is a significant positive step in promoting closer co-operation and better understanding between the respective industries in China and Ireland6.
Ireland is well-placed to support and complement China access investment strategies offering a range of regulatory structures such as UCITS that can be used to facilitate an RQFII strategy or access A shares via the Shanghai Hong Kong Stock Connect (or both) Ireland also offers a Qualifying Investor Alternative Investment Fund (an Alternative Investment Fund Managers Directive fund) which could be used to accommodate a QFII strategy as it provides greater flexibility than a UCITS in respect of investments and leverage.
Ireland has been leading the way in innovation regarding China access and was the first UCITS jurisdiction to offer European investor’s access to the China A-Shares via an Exchange Traded Fund.
Ireland is committed to supporting global asset managers' strategies for investment in China and the Chinese asset management industry's growth into global markets as evidenced by the Minister of State Simon Harris’s address to the Irish Fund’s Shanghai-Hong Kong Stock Connect Seminar in Hong Kong in January this year. In his address to the seminar, Minister Harris noted that: "The Fund Industry in Greater China presents both a major challenge and largest market opportunity within fund management this decade and into the next.” The Minister welcomed Irish Funds work assisting fund managers globalise their businesses7.
David McEvoy, BlackRock
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