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Why I’m investing only 20% of my portfolio in China

Disclaimer: SPONSORED CONTENT WITH OCBC Securities. All views expressed in this article are the independent opinion of The Woke Salaryman based on our research, and do not reflect OCBC Securities’ viewpoints.

As of the writing of this article, slightly less than 20% of my stock portfolio is in China. And while I intend to buy more stocks, I don’t intend to go more than 20%.

Depending on who you are, you might think I’m either:

  1. Ignorant for investing in a country that has a unique regulatory environment
  2. Overly conservative, missing out on the next big thing.

So yeah, conversations about China tend to evoke very strong opinions.

In this article, I’d like to explain why and how I invest in China, how I’m responding to the recent crackdowns, as well as what are the potential pitfalls of doing so.

The story that’s often sold:

Why invest in China?

To paraphrase Ray Dalio: It’s simply too big to be ignored.

Well, by now you should have heard these narratives. But let’s just go over these quickly.

China is the world’s up-and-coming economic superpower. Actually, it’s no longer up-and-coming. It’s the only economy to post strong growth over the past decade. China’s economy is expected to overtake the US economy. Some estimate as soon as 2028, and its middle-class consumers have experienced an explosion of wealth

Its companies have the potential to rival or even surpass the US. China has served a massive population with its own internet ecosystem for years. You know the names – Alibaba, Tencent, Meituan, etc.  But Chinese companies have also enjoyed success overseas.

As you might have heard, TikTok is a Chinese product. So is Genshin Impact. Or Black Myth: Wukong.

The fine print to the China growth story

Why not invest in China? Beneath the gloss of the China growth story are caveats that investors don’t always like hearing, but they must be said nevertheless.

GDP growth does not necessarily translate to stock market gains. A strong economy doesn’t necessarily mean stellar stock market growth.  This is not a Chinese thing, btw. You saw this during the COVID-19 pandemic last year, where the US stock market went up when unemployment was at an all-time high, even when the GDP was at a record low.

Despite China’s good GDP growth, its stock market index (MCHI, 35%) actually underperformed the US (S&P500, 240%) in the last 10 years.

Accounting risk. There have been a few significant cases of Chinese companies inflating their financial reports to make them look more appealing. Even though accounting risk is prevalent in other markets as well, accounting fraud is an especially real risk for investors in the Chinese market.

That said, this typically happens in smaller companies where management is not as transparent.

Further reading: Luckin Coffee saga, The China Hustle

Let’s talk about regulatory risk

We were thinking of lumping this in the above section, but decided that it deserved its own segment. Regulatory risk muddies the (already muddy) waters. And it’s probably the biggest reason why investors are shying away from China of late.

We will not mince our words. These concerns are very valid. The authorities hold ultimate power, and can put their foot down and enforce changes in ways that the US can’t even imagine. The China stock market represents a very different environment compared to the US one.

However, it’s a little simplistic to dismiss this to mean bad/uninvestable.

Instead, investors in China need to constantly check if the companies are aligned with the nation’s interests. 

What are the nation’s interests? I’m glad you asked. 

Since the 1970s, China has embarked on rapid economic growth. This approach lifted millions of people out of poverty, but has also caused many problems.

These include:

  • Income inequality and disillusionment (check out: lying flat culture
  • Aging population and low birth rates
  • Rising costs of living, unaffordable property prices 
  • Environmental and pollution issues
  • Unsustainable economic growth

Many of these are linked, and deserve an entire white paper on their own.

For the sake of brevity, we’d like to elaborate more on income inequality, as this is also tied to people having fewer children and is probably unacceptable for a nation which prides itself on being a modern socialist country.

Unlike the unbridled economic growth of the past few decades, China is increasingly preaching the ‘common prosperity’ mantra, with the goal of creating a nation where the middle-class hold much of the wealth – aka an ‘oliveshaped social structure’.

The authorities have not done anything to suggest that they want to create a country where everyone has equal wealth.

But they have suggested that they’d limit ‘unreasonable incomes’, and have shown that they are willing to make an example of billionaires and celebrities.

One example is the recent regulation of Chinese edtech companies. For years, Chinese news outlets have been reporting about how parents are overspending on expensive private education, leaving little for themselves.

To level the playing field in favour of parents, the regulators mandated that these companies were to become ‘not-for-profit’, which sent the stock prices crashing.

TL;DR: In the past, China said: get rich first, then pursue its ideals of equality and fairness. China is rich now, so you can connect the dots.

What does this mean for investors?

In my opinion, anyone investing in China should make sure that the companies they’re looking at are aligned with national interests. This is on top of any due diligence you might have done investing in other markets.

Officially, the government releases five-year-plans on where the nation is headed to in the next five years. This should also offer broad plans on the key industries China is focusing on, as well as its key concerns. Investors should definitely take a look.

Still, we want to stress that investing in China is a tricky affair, even for serious investors, much less casual ones.

You either:

You invest in China, but be prepared for higher volatility and manage your risks.

You allocate some of your portfolio to China, knowing that there’s the possibility of it being heavily disrupted by all the risks above. My own allocation is 20%, but what is comfortable for you could be something else.

For those who don’t pick stocks, one strategy worth considering is to diversify into more established companies, which tend to be more transparent and accountable. OCBC-Lion Securities has such an ETF – Lion-OCBC Securities China Leaders ETF (more on that later).

OR

You avoid China, till the dust settles and/or you understand more. There is no shame in not rushing to invest in something that’s objectively hard to understand. You can still do well yourself by focusing on other markets such as the US. The rules are more conventional there, and simple strategies such as index investing still work.

In the meantime though, it won’t hurt to read up more about China.

As the country continues to grow in prominence and influence, it’s more and more important for investors to know the motivations of the authorities before leaping in.

As Sun Tzu once said, “we cannot enter into alliances until we are acquainted with the designs of our neighbours.”

I’d like to think the same applies for investments.

Stay woke, salaryman.

Further reading:

A message from our sponsor, OCBC Securities

If you’re new to investing in the Chinese market, both potential and the risks involved are extremely real. That said, if you are interested in being part of the China growth story, you can consider the recently launched Lion-OCBC Securities China Leaders ETF. It is a collaborated launch by Lion Global Investors and OCBC Securities – familiar names to most Singaporeans.

The ETF gives you access to a diversified portfolio made up of old and new economy stocks, consisting of the 80 handpicked, large Chinese companies in terms of market cap.

Companies include Tencent (Info Tech), Ping An Insurance (Finance), Kewichow Moutai (Alcohol, Consumer Staples) and China Construction Bank (Finance).

This ETF is available on OCBC Securities, where you can trade and invest in the global market, China market and Singapore market, and 13 other exchanges.

To find out more about Lion-OCBC Securities China Leaders ETF, visit OCBC Securities website.

Disclaimers

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All views expressed here belong to and are independent opinions of The Woke Salaryman and are for information purposes only. They do not take into account the specific objectives, financial situation or particular needs of any particular person. You should not make any decisions without independently verifying or assessing the contents. OCBC Securities Private Limited (“OCBC Securities”) does not endorse and makes no representation or warranty whatsoever in respect of any view expressed here and shall not be responsible for any loss or damage whatsoever arising, directly or indirectly, howsoever as a result of any person acting on any view expressed here.

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