Investors ignore China at their peril. The country is the biggest contributor to global economic growth and its broad investment universe offers opportunities across a range of emerging industries. Challenges do exist, especially around the high level of regulation, but one investment director believes there is great potential to be found among the country’s domestic businesses.

Catherine Yeung  is Investment Director with Fidelity International. She says initiatives introduced by the Chinese government, specifically the $US 1 trillion One Belt, One Road initiative and the Made in China 2025 policy – the state-led industrial initiative to make China dominant in global high-tech manufacturing – are helping to open up its capital markets.

“The Made in China 2025 story is key from a government and corporate perspective and a consumer point of view, too,” Yeung says. “Many companies are receiving subsidies or support from the government if they can prove they’re part of the strategy, so are climbing up this value chain and becoming a lot more innovative. What’s really fascinating is that you can actually see the R&D and innovation coming through as a result.”

Yeung believes the 2025 policy is also likely to act as a catalyst for the changing relationship between the US and China. She says China is using both this strategy and the Belt and Road initiative to achieve its ambition of becoming the leading superpower.

“Even if we do see a resolution between US President Trump and President Xi Jinping on the tariff-related issue, the relationship between these two economies has changed. It’s become a lot more competitive, a lot less cooperative. Essentially, it’s Made in China 2025 versus Make America Great Again.”

Chinese understudy brands join centre stage

While China has one of the largest stock exchanges in the world, the country itself is still very much an emerging economy, according to Yeung. But value can be found across all sectors and industries.

“We're seeing a number of companies tapping into the domestic consumption story, which is still very much intact despite retail sales coming off at the end of last year,” she says. “But not all consumer names have a strong market share or a strategy going forward so there is an enormous amount of competition in this space.”

When it comes to Chinese companies, much of the investor attention is directed towards well-known names such as Alibaba and Tencent. But at look at the lesser known stocks can surprise with their attractive earnings and returns. Yeung says Chinese brands are becoming more in vogue and cites the sports apparel companies Li-Ning and Anta Sports as examples that are big among domestic consumers and which are now attracting international attention.

A rise in disposable incomes is also leading to an uplift in domestic consumption and a growing appetite for premium goods and services. “We still haven't seen the Chinese equivalent of a Chanel or Louis Vuitton,” Yeung says. “But maybe we’re going to see that trend emerge as designers come through who are very Chinese-centric in creating products that highlight local design.”

Innovating to stay competitive

However, there are many reasons why those seeking to invest in China would find it impossible to go past Tencent and Alibaba. They are both innovative, growing their revenue, and evolving to diversify away from their original core business.

“Alibaba made it very, very clear to us that they’re now tapping into the rural consumer market,” Yeung says. “Rural consumers spend differently to urban consumers. It’s all about the pricing point for them, and they don't really care at this stage about quality.”

While Alibaba and Tencent offer compelling reasons for investors to own both of them, Yeung says the market is becoming crowded. “Because these companies own so much of the ecosystem across China, they're long-term core names you can have in a portfolio. But with the rise of so many other companies in China, you can generate more alpha over a given period by diversifying away from these two names.”

Looking for the next dance

As China opens its capital markets, there is going to be more scrutiny on what its domestic companies deliver. Earlier this year, the STAR board was introduced. “Essentially, the Chinese government and regulators want it to be a Chinese Nasdaq,” Yeung says. “The listing rules are slightly different to Shenzhen, Shanghai and Hong Kong, but it’s called STAR because it represents science and technology innovation. We're seeing a number of companies list on the board, and that is really interesting in terms of highlighting the innovation space.”

One IPO, whose date is still to be confirmed, involves one of the most well-known profitable companies in China at the moment.

“It’s called ByteDance,” Yeung says. “Few Australians have probably heard of it but I’m sure many parents have heard of TikTok, which it owns. TikTok is its international business and it also has a domestic version under another name. ByteDance competes with WeChat , and this reinforces the competitive intensity that we’re seeing emerge among the less well-known companies.”

Yeung adds this competitive intensity is key to investing in China. “It’s great for Chinese people in terms of all these services and e-commerce sites becoming available, but from an investment perspective, you have to be really mindful about those companies that can have somewhat sustainable earnings going forward.”

Time for a long-term approach

Historically, Chinese mainland investors tend to be very short-term, momentum investors who are in and out of trades quickly. But Yeung says if you can encourage companies to pay higher dividend yields, increase the payout ratio, and look at the income side of the equation, then this will entice domestic investors to consider equities from a long-term perspective.

“Ultimately, this is really, really important and potentially really profitable for foreign investors, such as those sitting in Australia, because your opportunity set increases,” she says. “So, you have better-managed companies because of the focus on total return, not just capital appreciation. Long term, one of the most attractive reasons for investing in the China market is the income part of the story.”

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