Chinese equities have seen strong net inflows since November, but most stem from covering short positions as investors have largely taken a wait-and-see approach as they try to figure out whether the recent market rally is a blip rather than a long-term investment play.
Meanwhile, those investors that stood firm and retained their exposures to Chinese equities are now reaping the rewards.
By Jan. 30, year-to-date net inflows to mainland Chinese stock exchanges through the Stock Connect scheme had reached 131.1 billion yuan ($19.6 billion), surpassing net inflows for the whole of 2022 of 90 billion yuan, according to data from the Stock Exchange of Hong Kong Ltd.
The CSI 300 index and Hang Seng index have risen 6.9% and 8.4%, respectively, year-to-date as of Jan. 31 — a big difference vs. performances of -22% for the CSI 300 and -15% for the Hang Seng index in 2022.
On Jan. 8, China lifted its strict zero-COVID policies, allowing quarantine-free arrivals and removing mandatory testing and lockdown requirements.
Asset managers said they have seen a sharp rise in interest into the Chinese stock market from institutional investors since then, with money beginning to flow in January. In November and December, investors were covering short positions on Chinese exposures, said Ricky Tang, managing director and co-head of client portfolio management at Hong Kong-based Value Partners Group Ltd.
However, there has been a large increase in the number of conversations with institutional investors since November, but they are "unsure about the timing, as the markets have rallied quite substantially since end October 2022," he said.
"Hence, a key question is if there is still upside, or will there be a pullback. Many are also still a little concerned about the execution and continuity of the policy direction given what happened over the last two years, as well as the pandemic situation with the reopening as the infection rate has skyrocketed," he added.
"A lot of folks are renting this rally rather than being committed to it," Michael Edwards, New York-based deputy CIO at Weiss Multi-Strategy Advisers LLC, agreed in a video interview on Jan. 17. "We are 11 trading days into the year, and Hong Kong, Europe and Mexico are up by enormous numbers. If investors are missing this performance, you're feeling it and it's hurting."
The recent rally came as rumors swirled in November that China was considering lifting its COVID-19 policies. On Dec. 7, Chinese authorities announced that it would lift its strict lockdown policies in areas with COVID-19 infections and reduce the scale of mandatory PCR testing, prompting more investor confidence as the benchmark CSI 300 rose further.
This came in sharp contrast to the stock market's performance during China's three years of aggressively maintaining its zero-COVID policy. Chinese markets were volatile; the benchmark CSI 300 fell 39.6% from its all-time high in February 2021 to its two-year low in October 2022.
However, money managers generally agreed that it's not too late to get in on the action and reallocate to Chinese equities, as valuations are still relatively low and there could be a compelling entry point to come, with the expectation of a pullback as companies report their fourth-quarter earnings, which are expected to be weak.
"While a large part of the rally thus far has been driven by (price-earnings) multiples expansion, we believe there is further upside from earnings upward re-rating in the next couple of months as the recovery takes further momentum," Value Partners' Mr. Tang said in written comments.
"With that said, it is also likely for us to see some volatility as companies start report their earnings for Q4 2022, which are expected to be quite weak given the challenging operating environment last year. We believe that the short-term pullback, if any, could actually present a good entry point for investors who have yet to rebuild their positions in China," he added.
Value Partners had $6.1 billion assets under management as of Dec. 31.
Still, some long-term investors are opting for a wait-and-see approach.
"We have to re-look at our assumptions. We used to assume that whatever Chinese leadership says will happen, but we have learned that there are many layers between leadership and on-the-ground execution," one Asia-Pacific head at a global fund manager said.
"So we are taking a step back for a few months to see how this opening of the border will pan out," she said, speaking on condition of anonymity.
There are also questions about a potential second or third wave of COVID-19 and concerns over some countries mandating the testing of passengers from China, said Marko Tutavac, managing director at Hong Kong-based VMS Asset Management Ltd., which has $4.2 billion AUM as of Sept. 30.
He observed that institutional investors are still unsure about the prospects of Chinese equity. "The HOPE is that China will eventually return to moderate annual growth and a continued evolution of its economy," he said in an email.
He added that the next six months are critical as investors continue to keep an eye on the progress of China's reopening.
Then there are the investors who have been constructive on Chinese equities and chose to hold onto their positions — even during the dip.
"During the market sell-off following the Party Congress in October 2022 — when the Chinese government did not signal any meaningful change in its zero-COVID policy — we advised our clients to hold on to Chinese equities as part of the long-term value-based investing approach that we advocate," said Aaron Costello, Singapore-based regional head for Asia at Cambridge Associates Asia Pte. Ltd. Cambridge Associates has $500 billion of assets under management globally.
"We believed that because markets could react quickly and powerfully to any change in zero-COVID policy, it will be very difficult for investors to time the pivot. As a result, our clients' portfolios have benefited from the Chinese government's recent pivoting of its zero-COVID policy," Mr. Costello said.
The firm is sticking to its modest overweight to Chinese equities as "even with the recent rally, the current valuations are still in the bottom decile compared to history," he said. "As China comes out of a self-imposed recession, we expect the next leg of the China rally to be driven by a sharp recovery in its earnings and economy."
Similarly, Singapore-headquartered APS Asset Management, a $2.5 billion fund house that specializes in Chinese funds, had stuck to its Chinese equity strategy and had been "close to fully invested" even before the rebound, said founder and CIO Wong Kok Hoi.
He also noted that international investors, particularly hedge funds, are more bullish on Chinese stocks than domestic investors for now, although U.S. funds, such as public pension plans, were limited in their ability to allocate further into China due to political reasons.
Market participants are also keeping their eye on China's economic numbers ahead of investing. On Jan. 17, China released 2022 statistics that showed growth had slowed to 3%, compared with 8.1% in 2021. It also revealed that its population had declined for the first time since 1961.
Despite the alarmist headlines, several money managers were pleasantly surprised by the GDP numbers and said that China's economy will only grow from here, which presents strong opportunities for investors, particularly in the consumer and service sectors.
Aidan Yao, senior emerging Asia economist at AXA Investment Managers Asia Ltd., said that the fourth-quarter growth was stronger than expected, but raised questions about some of the data.
"December has likely marked the darkest before the dawn for the Chinese economy. As COVID comes and goes at an extremely fast speed, normalcy is being restored in cities that have passed the peak of infections. Daily data on traffic congestion, metro ridership, freight volumes and house sales all bottomed in the middle of December and a recovery has taken hold since," he wrote in a commentary.
While admitting that the data could reflect the market's underestimation of traffic and mobility in the second half of December, he said that "the way in which some data beat expectations still raise questions."
"For example, the narrowing growth decline of services production and retail sales seems counterintuitive given the worsened COVID situation had reduced mobility in most part of December. Today's data also showed a strong rebound in fixed asset investment growth from 0.7% to 3.1%. While it is possible that the policy push to complete unfinished projects had helped housing construction, the gains in manufacturing and infrastructure investment were inconsistent with the weak PMI," he said.
