Insight Article Desktop Banner
 
 
Insight Article
  •  
July 30, 2020
Fishing for Stocks in China
Insight Video Mobile Banner
 
July 30, 2020

Fishing for Stocks in China


Insight Article

Fishing for Stocks in China

Share Icon

July 30, 2020

 
 

We discuss how we are finding bottom-up stock ideas in China driven by consumption growth and highlight four specific areas where we see vast opportunity: consumer, internet, healthcare and education.

 
 

China Stock Market Is Misunderstood

Our location in Hong Kong, extensive research of companies across Asia and significant allocations to China for more than a decade across the Opportunity Strategies give us a unique perspective on the risks and opportunities of investing in China. In recent years, China’s economic transition, rising debt and political risk have raised concerns in the markets. Indeed, it’s hard to go a single week without a major negative article in the press. While we don’t share a belief in the inevitability of the draconian view, if there are large scale policy missteps, China could become one of the more likely sources of financial contagion due to its sheer size and disproportionate share of worldwide economic growth. We are encouraged that consumption growth has been increasing as a driver of China’s economic expansion. That strikes us as more sustainable. Furthermore, we continue to find compelling bottom-up stock ideas in China, a market that surprisingly makes up 46 percent of the global companies that pass our high quality screen—this is an impressive result (Display 1).1

 
 
 
Display 1: China is under-represented by the equity indices
 

Source: Morgan Stanley Investment Management/FactSet, United Nation Population Division, IMF and MSCI. GDP is on a PPP basis. Data as of January 2020.

 
 

It means that investors should not ignore China regardless of their macro view. Let’s examine together the transformation we are seeing first-hand in China to present a different side of the story, one where ignoring China can mean a large risk of missing out on what we believe to be some of the greatest bottom-up stock ideas of the next decade.

We believe that China is ripe with opportunity for bottom-up stock picking. Whereas historically China’s stock market was primarily comprised of state-owned enterprises (SOE), non-SOEs now represent more than half of the market capitalization of the MSCI China Index at 52 percent in 2020 versus just 5 percent in 2005.2 An increasing number of private companies concentrated in the consumer, healthcare and technology sectors are now accessible to international investors via the Hong Kong Stock Connect program for China A shares listed in Shanghai and Shenzhen.

China Is Under-Represented by Equity Indices

China offers vast opportunity to investors willing to extend their time horizon and take a long-term view. Regardless of the consensus view that short-term real gross domestic product (GDP) growth is slowing, China represents nearly 1/5 of the world’s economy an population; yet is under-represented by global equity indices at less than 1/20 (4.5 percent) of the MSCI All Country World Index (Display 1). In the years ahead, we expect that gap to narrow as China’s economy evolves and innovative companies address China’s growing demand for consumption and services, thus necessitating an increase in index weightings for China. Maybe the Chinese economy doesn’t grow at 6 percent anymore and that’s perfectly ok. Let’s assume for the sake of argument that China only grows at 4 percent over the next decade. Isn’t that still better than the zero to 2 percent that most of the developed world has been growing at for the last decade and likely into the future?

China’s Net Debt Is Lower Than Advanced Economies

Pundits have noted China’s rapid increase in leverage to nearly 300 percent of GDP over the last decade, as well as declining profitability and excess investment capacity. Although unforeseen political developments and trade protectionism also present risks, a key leading indicator to watch going forward, in our view would be any rise in non-performing loans in consumer sectors outside of heavy industries.

We believe, however, that the risk of a financial blow-up in the next three years is, although still possible, perhaps overstated at this time by the media. Nearly half of China’s leverage is contained within the financial system and government-owed debt, which is controllable in a command economy. Further, after taking into account the high savings rate in China, the ratio of net debt in China is only 48 percent of GDP, which is far lower than that of Japan, the U.S. and other major economies (Display 2).

 
 
 
Display 2: Net debt as percentage of GDP
 

Source: Bloomberg. Data as of June 2020.

 
 

Consumption Growth Now Drives China’s Economy

China’s economy is undergoing a massive transition from fixed asset investment in heavy industry and manufacturing to growth in consumption and services. The contribution to GDP from consumption has averaged 4.6 percent over the past decade (Display 3). China’s consumption growth provides investors with a baseline to expect from the economy going forward: even without the benefit of growth in investment or exports, the world’s second-largest consumer will likely continue to grow faster than the developed world in the years ahead based on consumption growth alone.3

 
 
 
Display 3: Contribution to China GDP growth, 2009-2019
 

Source: Morgan Stanley Research, as of December 2019.

 
 

A Billion Consumers Want What We Want

Over 800 million people have emerged from poverty in China since market reforms were introduced in 1978.4 This emerging middle class wants what those in developed markets have long enjoyed and perhaps take for granted: higher quality consumable products such as food and beverages, internet services to share experiences with family and friends, access to healthcare and better education opportunities for their children.

Consumption upgrade demand across food, beverages, household products and personal care continues to outpace that of developed economies. We are attracted to the defensive characteristics of domestic staples categories and specifically of companies with demonstrated competitive advantages sustained through strategies of brand differentiation and cost leadership. Two areas we find particularly compelling are beverages, in which the domestic market appears to be consolidating as leaders capture share in the beer and baijiu spirits markets by leveraging strong brands through superior distribution and execution; and food, where nimble players in niche categories such as soy sauce are delivering stable growth through market consolidation and product premiumization. Over the long-term, household consumption in China is expected to shift from basic necessities to increased discretionary spending as a burgeoning middle class emerges.

Internet

Chinese internet users now total 854 million, more than 61 percent of the overall population, with 99 percent accessing via mobile,5 yet there remain over 540 million people without access to the internet in China (Display 4). The accompanying changes in consumer behavior benefit domestic social networking, e-commerce, gaming and online travel platforms. The USD 55 billion online advertising market has grown at a 26 percent compound annual growth rate over the last five years.6 Advertising on social networks is growing its share of the pie driven by increased monetization. Meanwhile, e-commerce as a percentage of retail is over 36 percent in China, higher than the U.S., as online leapfrogs offline retail in China which has not developed modern offline retail at scale.7 We believe that continued growth in engagement of the China internet population which now spends over six hours per day on digital media,8 will continue to benefit businesses that leverage the internet as a distribution platform.

 
 
 
Display 4: Internet penetration in China, 2003-2019
 

Source: China Internet Network Information Center (CNNIC), eMarketer. Data as of August 2019.

 
 

Healthcare

China’s healthcare spending totals 5.2 percent of GDP, compared to over 10 percent in Europe and Japan, and over 17 percent in the U.S. (Display 5). As China’s population ages and increases in wealth, we expect healthcare spending to rise. Two areas we find particularly compelling include healthcare equipment and services and pharmaceuticals, where the emergence of domestic players with advanced research and development capabilities in oncology, infectious diseases and generic medications is expanding China’s healthcare industry.

 
 
 
Display 5: Health expenditure as percentage of GDP
 

Source: Morgan Stanley Research, World Development Indicators, EuroStat. Data as of December 2017.

 
 

Education

Education is a high priority for Chinese families, particularly in foreign languages, mathematics and science, which are key to passing the gaokao (高 考) national higher education entrance examination. Top Chinese universities accept students at half the rate of leading U.S. institutions intensifying competition for university entrance and driving a surge in demand for high quality private educational services. Thus, we are attracted to the private educational market. It has experienced strong enrollment growth and should further benefit from the growth in disposable income and favorable demographics with more children following the end of China’s one child policy in 2015.

High Quality Stocks in China

After three decades of rapid real GDP growth driven by fixed asset investment in heavy industry, China is adjusting to a more moderate pace driven by consumption and services. Rebalancing the world’s second-largest economy is not without its well-known challenges, but as bottom-up investors we look through the short-term macro noise and have been finding plenty of high quality stocks in China. Therefore, we believe that if you want to find some of the best bottom-up stock ideas of the next decade, then look to China because as Charlie Munger, Warren Buffett’s long-time partner said about China, “It’s a happier hunting ground.”9

 
 
 
Display 6: High quality screen: Percentage of non-financial companies with both 15% sales growth and return on invested capital (ROIC)
 

Source: Morgan Stanley Investment Management/FactSet. Data as of Jan, 2020. Dataset is 6,211 non-financial companies above U.S. $1 billion market cap. 1. High-quality screen is defined by: a) historical three-year revenue CAGR above 15%; and b) ROIC above 15%. 2. While representative, regional domicile is not the same as economic exposure in revenue terms. 3. High-quality companies typically have a higher percentage of sales from outside their home country than the index.

 
 

1 Morgan Stanley Investment Management/FactSet. Data as of January 2020. High-quality screen is defined by: a) historical three-year revenue CAGR above 15%; and b) ROIC above 15%. Refer to Display 6.

2 Morgan Stanley Research, as of June 2020.

3 Morgan Stanley Research, as of December 2019.

4 World Bank, China Overview as of March 2017.

5 China Internet Network Information Center (CNNIC), as of August 2019.

6 China Internet Network Information Center (CNNIC), as of March 2019.

7 eMarket, as of June 2019.

8 eMarket, as of May 2019.

9 Charlie Munger, Vice Chairman of Berkshire Hathaway; 2017 Annual Meeting, as of May 2017.

 

RISK CONSIDERATIONS

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in these portfolios. Please be aware that these portfolios may be subject to certain additional risks. Changes in the worldwide economy, consumer spending, competition, demographics and consumer preferences, government regulation and economic conditions may adversely affect global franchise companies and may negatively impact these portfolios to a greater extent than if these portfolios’ assets were invested in a wider variety of companies. In general, equity securities’ values also fluctuate in response to activities specific to a company. Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds (ETFs), the portfolio absorbs both its own expenses and those of the ETFs it invests in. Supply and demand for ETFs may not be correlated to that of the underlying securities. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Asia market entails liquidity risk due to the small markets and low trading volume in many countries. In addition, companies in the region tend to be volatile and there is a significant possibility of loss. Furthermore, because the strategy concentrates in a single region of the world, performance may be more volatile than a global strategy. Privately placed and restricted securities may be subject to resale restrictions as well as a lack of publicly available information, which will increase their illiquidity and could adversely affect the ability to value and sell them (liquidity risk). Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. To the extent that the Fund invests in a limited number of issuers (focused investing), the Fund will be more susceptible to negative events affecting those issuers and a decline in the value of a particular instrument may cause the Fund’s overall value to decline to a greater degree than if the Fund were invested more widely. China Risk. Investments in China involve risk of a total loss due to government action or inaction. Additionally, the Chinese economy is export-driven and highly reliant on trade. Adverse changes to the economic conditions of its primary trading partners, such as the United States, Japan and South Korea, would adversely impact the Chinese economy and the Fund’s investments. Moreover, a slowdown in other significant economies of the world, such as the United States, the European Union and certain Asian countries, may adversely affect economic growth in China. An economic downturn in China would adversely impact the Portfolio’s investments. Risks of Investing through Stock Connect. Any investments in A-shares listed and traded through Stock Connect, or on such other stock exchanges in China which participate in Stock Connect is subject to a number of restrictions that may affect the Portfolio’s investments and returns. Moreover, Stock Connect A shares generally may not be sold, purchased or otherwise transferred other than through Stock Connect in accordance with applicable rules. The Stock Connect program may be subject to further interpretation and guidance. There can be no assurance as to the program’s continued existence or whether future developments regarding the program may restrict or adversely affect the Portfolio’s investments or returns.

 
kristian.heugh
Managing Director
Counterpoint Global
 
marc.fox
Managing Director
 
 
Featured Funds
 
 
 
 
 

INDEX INFORMATION

The MSCI All Country World Index (ACWI) is a free float-adjusted market capitalization weighted index designed to measure the equity market performance of developed and emerging markets. The term “free float” represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends. The MSCI China Index captures large and mid-cap representation across China A-shares, B-shares, H-shares, Red-chips and P-chips. It reflects the Mainland China and Hong Kong opportunity set from an international investor’s perspective. The MSCI All Country World Index (ACWI) is a free float-adjusted market capitalization weighted index designed to measure the equity market performance of developed and emerging markets. The term “free float” represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends.

DISTRIBUTION

This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

Ireland: Morgan Stanley Investment Management (Ireland) Limited. Registered Office: The Observatory, 7-11 Sir John Rogerson’s, Quay, Dublin 2, Ireland. Registered in Ireland under company number 616662. Regulated by the Central Bank of Ireland. United Kingdom: Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA. Dubai: Morgan Stanley Investment Management Limited (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158). Germany: Morgan Stanley Investment Management Limited Niederlassung Deutschland, Grosse Gallusstrasse 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Italy: Morgan Stanley Investment Management Limited, Milan Branch (Sede Secondaria di Milano) is a branch of Morgan Stanley Investment Management Limited, a company registered in the UK, authorised and regulated by the Financial Conduct Authority (FCA), and whose registered office is at 25 Cabot Square, Canary Wharf, London, E14 4QA. Morgan Stanley Investment Management Limited Milan Branch (Sede Secondaria di Milano) with seat in Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy, is registered in Italy with company number and VAT number 08829360968. The Netherlands: Morgan Stanley Investment Management, Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. Telephone: 31 2-0462-1300. Morgan Stanley Investment Management is a branch office of Morgan Stanley Investment Management Limited. Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Switzerland: Morgan Stanley & Co. International plc, London, Zurich Branch Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered with the Register of Commerce Zurich CHE-115.415.770. Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland, Telephone +41 (0) 44 588 1000. Facsimile Fax: +41(0) 44 588 1074.

U.S.: A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment manager, please refer to Form ADV Part 2.

Please consider the investment objectives, risks, charges and expenses of the funds carefully before investing. The prospectuses contain this and other information about the funds. To obtain a prospectus please download one at morganstanley.com/im or call 1-800-548-7786. Please read the prospectus carefully before investing.

Morgan Stanley Distribution, Inc. serves as the distributor for Morgan Stanley funds.

NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT

Hong Kong: This document has been issued by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this document have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this document shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This document should not be considered to be the subject of an invitation for subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of Singapore (“SFA”); (ii) to a “relevant person” (which includes an accredited investor) pursuant to section 305 of the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore. Australia: This publication is disseminated in Australia by Morgan Stanley Investment Management (Australia) Pty Limited ACN: 122040037, AFSL No. 314182, which accept responsibility for its contents. This publication, and any access to it, is intended only for “wholesale clients” within the meaning of the Australian Corporations Act.

Japan: For professional investors, this document is circulated or distributed for informational purposes only. For those who are not professional investors, this document is provided in relation to Morgan Stanley Investment Management (Japan) Co., Ltd. (“MSIMJ”)’s business with respect to discretionary investment management agreements (“IMA”) and investment advisory agreements (“IAA”). This is not for the purpose of a recommendation or solicitation of transactions or offers any particular financial instruments. Under an IMA, with respect to management of assets of a client, the client prescribes basic management policies in advance and commissions MSIMJ to make all investment decisions based on an analysis of the value, etc. of the securities, and MSIMJ accepts such commission. The client shall delegate to MSIMJ the authorities necessary for making investment. MSIMJ exercises the delegated authorities based on investment decisions of MSIMJ, and the client shall not make individual instructions. All investment profits and losses belong to the clients; principal is not guaranteed. Please consider the investment objectives and nature of risks before investing. As an investment advisory fee for an IAA or an IMA, the amount of assets subject to the contract multiplied by a certain rate (the upper limit is 2.20% per annum (including tax)) shall be incurred in proportion to the contract period. For some strategies, a contingency fee may be incurred in addition to the fee mentioned above. Indirect charges also may be incurred, such as brokerage commissions for incorporated securities. Since these charges and expenses are different depending on a contract and other factors, MSIMJ cannot present the rates, upper limits, etc. in advance. All clients should read the Documents Provided Prior to the Conclusion of a Contract carefully before executing an agreement. This document is disseminated in Japan by MSIMJ, Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.

IMPORTANT INFORMATION

EMEA: This marketing communication has been issued by Morgan Stanley Investment Management Limited (“MSIM”). Authorised and regulated by the Financial Conduct Authority. Registered in England No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Prior to investing, investors should carefully review the strategy’s / product’s relevant offering document. There are important differences in how the strategy is carried out in each of the investment vehicles.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing.

The views and opinions are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment teams at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific Morgan Stanley Investment Management product.

Certain information herein is based on data obtained from third party sources believed to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness. The information herein is a general communications which is not impartial and has been prepared solely for information and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Past performance is no guarantee of future results.

Charts and graphs provided herein are for illustrative purposes only.

This communication is not a product of Morgan Stanley’s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the applicable European regulation or Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.

MSIM has not authorized financial intermediaries to use and to distribute this document, unless such use and distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are required to satisfy themselves that the information in this document is appropriate for any person to whom they provide this document in view of that person’s circumstances and purpose. MSIM shall not be liable for, and accepts no liability for, the use or misuse of this document by any such financial intermediary.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without MSIM’s express written consent.

This document may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this document in another language, the English version shall prevail.

All information contained herein is proprietary and is protected under copyright law.

 

It is important that users read the Terms of Use before proceeding as it explains certain legal and regulatory restrictions applicable to the dissemination of information pertaining to Morgan Stanley Investment Management's investment products.

The services described on this website may not be available in all jurisdictions or to all persons. For further details, please see our Terms of Use.


Privacy & Cookies    •    Terms of Use

©  Morgan Stanley. All rights reserved.