Year of the Rabbit: Investors warm towards China but hesitation ...

While dynamics are now shifting in a favourable direction, benefiting Chinese stocks and global growth, investment experts remain wary and advise caution. 

Chinese equities took a beating in the year of the tiger, with the collapse of the nation's property market, stringent restrictions on some of its sectors and its zero-Covid policy all hampering investor interest.

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"2022 merely served to compound a number of structural and cyclical issues facing the Chinese economy, as well as extend the stock market's underperforming trend since late 2020," explained Ewan Thompson, fund manager of the Liontrust Emerging Market fund.

He said in 2022, some global investors went so far as to label the nation as "uninvestable".

Unsurprisingly, the country's equity markets took a hit, with the MSCI China index down 45% off its peak in February 2021, according to FE fundinfo data.

However, things look promising in 2023, with the Hang Seng and Shanghai Composite indices posting strong gains so far this year.

This has led the huge technology companies of Tencent and Alibaba to gains of a combined $350bn in market value, according to Financial Times calculations based on Bloomberg data.

The gains in equity markets built momentum when Beijing began rapidly lifting its Covid-19 restrictions.

This came as a surprise to markets, which were anticipating a gradual loosening of restrictions throughout the coming spring.

The abrupt policy shift has made for a more favourable macro-economic backdrop, which is "foregrounded in investors' minds", according to Thompson.

China is experiencing a significant uptick in economic activity thanks to the re-opening, including freight, air and subway traffic. 

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However, Covid-19 challenges remain for the nation, as infections in China have surged since the easing of restrictions.

Xi Jinping took the unusual step of expressing concern about the spread of Covid-19 to rural China, his most direct acknowledgment of the worsening health crisis.

His worries came as officials forecast that two billion trips would be taken by Chinese people to see family in the coming weeks for New Year celebrations.

"Will China be forced into reverse if its healthcare system comes under pressure under a wave of infections? There certainly seems to be anecdotal evidence that hospitals are already ‘extremely busy' with Covid patients," wrote Will McIntosh-Whyte, a fund manager on the multi-asset team at Rathbones, in a blog post.

"There is certainly the risk of further supply disruptions to come, especially if lockdowns make a return."

However, by and large, investment managers are optimistic.

Ross Barr, senior investment strategist at Cardano, said the firm is anticipating the country to have herd immunity this quarter, with the second quarter showing an acceleration in growth as "pent-up demand comes through".

"In large cities, most people have been infected, already recovered and returned to work," said Jian Shi Cortesi, investment director at GAM.

"Traffic is back. Popular restaurants are packed again. Investor sentiment has started recovering. Some investors have moved to increase their China exposure."

Several commentators pointed to the built-up savings of the Chinese population, which is set to be deployed over the coming months. Analysts have estimated this to be worth around 5% of GDP.

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Zhixin Shu, senior equity analyst at J Stern & Co, said the firm believes retail sales in China will register double-digit growth this year.

"The re-opening will particularly fuel spending on discretionary, services, travel and cross-border duty-free shopping," she said. 

This should all boost Chinese overall GDP growth, which was faltering last year, when it expanded by just 2.9% in the fourth quarter, according to China's National Bureau of Statistics.

Analysts now anticipate GDP growth to be 5% for 2023, which Thompson said "will be a welcome support" for the struggling global economy.

On top of this, market participants are encouraged by the "pro growth policy shift" signalled at the annual Central Economic Work Conference at the end of last year, explained Fiona Yang, co-manager of the Invesco Asia fund.

The CEWC stressed the importance of getting the economy back on track with the help of a proactive fiscal policy and prudent monetary policy.

Additionally, some of the concerns over the property market have also been tackled, explained Thompson, with "direct injections of equity into key markets".

Despite all this positivity, there remain serious questions and risks around investing the country.

For example, while technology shares have boomed, the Financial Times has reported that this is in part thanks to the Chinese government taking "golden shares".

This usually involves taking a small equity stake, around 1%, a board seat and the right to review content.

Whyte noted, that while "Western press around such matters has often been unfounded, it still highlights the rising risk from intervention".

He added that Rathbones believes the long-term investment case for Chinese equities has "dimmed" as a result of the increasing intervention by the government in markets in order to obtain its goal of ‘common prosperity'.

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Similarly, Barr said the nation "represents a short-term opportunity" and he considers his position, which he built up in the final quarter of last year, "to be tactical in nature".

His concerns include the economy's shift towards services rather than goods production, and the fact the property sector will no longer drive growth as it had done previously.

Geopolitical tensions also remain a concern for several experts.

In an interview with Sky News, Taiwan's foreign minister said he believes China is now "more likely" to invade, with the action most likely to happen in 2027.

Tensions with the US have also been elevated. In December, the US added three dozen Chinese companies to an export blacklist so they could not attain American technology.

Earlier in the year, the nation also introduced rules that would make it harder for China to obtain or produce high-end semiconductors.

Dzmitry Lipski, head of fund research at interactive investor, said: "Ultimately, there are no easy answers when it comes to investing in China, but it is a hard region to avoid, whether it comes to investing, or through our everyday lives, from technology and beyond.

"Investors need to tread carefully, but a good way to get exposure to the region is through a fund or investment trust."

For those looking to invest, Lipski pointed to the Fidelity China Special Situations trust, which he said provides "broad, diversified exposure".

The trust focuses on faster growing, consumer-orientated companies. Given it is a single country exposure, it can be more volatile and higher risk.

For a broader holding, he suggested the Fidelity Asia or Guinness Asian Equity Income funds.

Kyle Caldwell, collectives specialist at interactive investor, added that as the second largest economy it is hard for investors to ignore China in their portfolios. 

He highlighted that some global funds and trust can have significant exposure. Scottish Mortgage, for example, has nearly 10% in China.

However, not all global funds will have a large or any exposure so emerging market funds may offer a way to gain access to the country in a diversified manner, he added.