Markets overreacted to China tightening, says Neuberger Berman
Yulin (Frank) Yao is senior portfolio manager for Neuberger Berman's Greater China equity team in Hong Kong, having joined the US asset manager in 2008.
He was previously a senior portfolio manager at Avenue Capital, where he directed the investment activities of the Avenue Greater China equity funds. Before that, he was chief investment officer at Hua An Fund Management from 2004 to 2007.
Yao is a member of the Standing Committee of the Chinese People's Political Consultative Conference in Shanghai and sits on the QDII Expert Committee for the China Securities Regulatory Commission. He was also a member of the Financial Market Expert Group for the People's Bank of China from 2005 to 2007.
We asked him his views on China's recent tightening measures, the likely effect of stock-index futures and investment opportunities for the coming months.
Following China's recent tightening moves, what effect have you seen this have on investments in Chinese assets by both local and foreign investors, and what effects do you envisage in the future?
The market has overreacted to the government's tightening moves and, in many ways, the reaction has been delayed. Tightening measures were gradually implemented from August, yet the market did not react in gradual lock-step. Economically sensitive sectors like steel and iron even outperformed the market in the fourth quarter. If the market had properly priced in the gradual tightening measures, these two groups would not have performed well. The market was caught by surprise in early January and again in early February, when the government increased the bank reserve requirement ratio, each time by 50 basis points.
The reaction to Chinese assets by local and international investors have been similar. Economically sensitive sectors -- such as materials, metals, steel and iron -- have been negatively affected, while defensive sectors, such as consumer staples, have held up relatively well. For domestic A-share and Hong Kong markets, we expect this trend to continue in the near term.
In the mid-term, we anticipate the market will differentiate between companies -- within the same sector -- that are sensitive to different macroeconomic indicators. Managers with deep sector and company knowledge can be helpful in exploiting these opportunities.
When stock-index futures are introduced in China, what effect do you expect them to have on the equity markets both on the mainland and in Hong Kong?
The introduction of stock-index futures for the domestic A-share market will have a positive impact on the market's development in the mid and long term. This will fundamentally change the A-share market from the current single directional market. It will offer more flexibility for managers to hedge against their market exposures. It will also bring the A-share market structure more in line with the Hong Kong market and many other developed markets.
The net effect will be an enhancement of liquidity for the China markets. Over the long term, these capabilities can reduce market volatility and encourage more long-term institutional and individual market participants both domestically and from abroad.
What is a feasible time scale for the launch of stock-index futures?
Regarding timing, that's the million-dollar question. Unless there are significant movements in the market, based on statements from the China Securities Regulatory Commission, China stock-index futures are expected to go live as early as the second or third quarter of this year.
What investment themes are you focusing on?
We are currently focused on domestic consumption and emerging market infrastructure. While both of these may seem obvious themes today, they were not so evident two-and-a-half years ago. We consider domestic consumption as sectors including food and beverage, agriculture, health care/pharmaceutical, real estate, online entertainment and retail. The percentage of the population in China with annual income of $2,500-13,000 is expected to rise from 9% in 2005 to 59% in 2025. As a result, urban household disposable income is expected to rise from $48 billion in 2005 to over $1.5 trillion in 2025.13
In addition to domestic consumption, another area with interesting investment opportunities is emerging-market infrastructure -- in other words, Chinese companies involved in businesses such as ports, highways, and railways. We tend to pay more attention to companies that are equipment and service providers rather than the actual infrastructure companies because many infrastructure companies in China are still state-owned enterprises. Therefore, they are not always the most efficient, nor do they necessarily have the best management teams in place. Instead, we concentrate on the companies with strong fundamentals and high visibility of top and bottom lines that provide services or supply products to infrastructure companies.
Where do you still see investment opportunities?
There are several sectors we feel are particularly interesting. First, the pharmaceutical and health-care sectors provide long-term investment opportunities to both international and domestic investors. We are seeing positive developments in China, as the government works towards establishing a universal health-care system for its 1.3 billion people.
We also think domestic consumption is an especially interesting theme, particularly in those sectors with high visibility of top- and bottom-line growth. An example of this is the online entertainment/gaming sector, where a number of companies are likely to have very meaningful top-and bottom-line growth for the next three to five years.
Third, we think potential inflation beneficiaries -- such as food and beverage, retail and insurance companies -- could be interesting. Clearly, in order to successfully exploit this theme in these areas, we will need to closely monitor the key indicators of inflation.
Finally, we are examining opportunities within the so-called 'regional disparities' in China. We find that the disparity of GDP growth between different provinces and regions across the country can be rather large. For example, the 2009 GDP for Inner Mongolia was about 17%, versus 7% for many tier-one cities like Shanghai. In general, tier-one cities with large, developed populations and industries will tend to grow more slowly in the future, whereas tier-two and three cities (inland cities) will most likely grow more rapidly. The difference in these rates could present some interesting opportunities for us to explore. [This is something others have also pointed out.]