After 18 months of working from home from a small village in Wiltshire, I’m starting to remember what it was like living on a remote island. My world has gotten that much smaller. Long ago, I lived in Guernsey (nine miles by three) – for more than two decades! Self-governed, largely independent and surrounded by a seawall, even British politics seemed irrelevant. Travelling anywhere requiring longer than 10 minutes was an ordeal to be avoided. In that environment only local matters and local is safe. I bet quite a few of us can identify with that hyper-local mindset after so long cooped up in our homes and neighbourhoods.
It seems that the Chinese government may be feeling the same pull of keeping things close to home. Recently there have been a few signs that the government appears to be trying to rein in some companies that may have become a bit too globe-trotting in their investor-base for China’s liking. Late last year regulators forced Ant Group, the digital payments spin-off from ecommerce giant Alibaba, to abandon its listing on the Shanghai exchange. Last month ride-sharing app Didi Chuxing was pulled from Chinese app stores days after it brushed aside regulatory concerns about data security to list in New York. They have levied a record $2.8 billion fine on Alibaba for anti-trust violations, and regulators are investigating food delivery app Meituan and internet and gaming conglomerate Tencent for the same issues. Then, overnight the government seemingly abolished for-profit education in core subjects for kids up to 15 years old, sending an entire industry into freefall.
Many investors are concerned about an ever wider crackdown on private enterprise in what is, lest we forget, a nominally communist state.
Tools and results
So are we seeing the pendulum of Chinese politics shifting back towards more statist solutions after several decades spent rapidly expanding its use of capitalist institutions and markets? In other words, is it going local – back to its comfort zone of intervention and control?
These actions are reason for us to pause and seriously reconsider our approach to investing in China. However, it’s really important that we try to understand the issues from China’s perspective rather than through the Western lens. The issues it is addressing are not unique: the West is also grappling with the tremendous power that the winner-takes-all online market creates in technology and data. Similarly, our school systems aren’t working as well as we would like, with ever more pressure for parents to stump up large and ever-increasing fees for kids to get a half-decent education. What makes China unique is that it has such blunt tools to simply make changes by decree.
Let’s start with technology. There are many in the West (me included) who worry about the power of large tech on society. I don’t mean on some weird conspiracy level, but the simple fact that innovation is often happening faster than legislation and societal norms can accommodate. I’m sure we can all think of negative impacts of large tech which we would like to irradicate.
Turning to education, the Chinese authorities felt that competition in education was putting too much pressure on children and creating a financial drain on parents that is possibly crimping the birth rate and affecting property prices. This was putting children of less wealthy parents at a huge disadvantage. Sound familiar?
To give some context, some Chinese children were receiving extra tuition to prep for interviews to get a place in kindergarten. Think about that: a three-year-old having to pass an entry exam to get into pre-school. The Chinese government says this was having a negative impact on the social cohesion of the country. Part of me cannot help but think that they have a point.
Is it possible that China, being later to the party, has looked at the Western model and decided it wants to go a different way and introduce regulation to curb some of the excesses? Should we be criticising or congratulating them?
Hammer or sickle
The execution is brutal, of course. Chinese leaders don’t need to put these policies to a public vote; they can do it overnight. But the rationale is something we can understand and that helps us when reviewing our commitment to Chinese assets.
We have been analysing the risks of changes in policy that could affect the stocks that we own. While these changes can appear bolts from the blue, they make sense in terms of an attempt to improve social cohesion in China. We have been looking at our exposure, avoiding sectors which could conceivably be on the wrong side of this objective. It’s kind of a Chinese Environmental Social Governance (ESG) risk isn’t it – that focus on inequality? At least that is how we are trying to think about this.
Some may argue that China’s country risk is now too high and it’s time for complete exit. We don’t think so. We will look for opportunities to add to technology companies, but with the assumption that regulation will be more rigorous than in the West. A known risk if you like. Similarly, any company using parents’ innate desire to provide a good life for their children to ramp up prices is probably not a very sustainable business.
All this brings us to the conclusion that you must be precise when investing in China – you can’t just buy the market. It is a large market, but one that is still maturing. Company governance is going to have to improve from here or authorities won’t just fine you, they will close you down (or your whole industry!).
In the short term, investor wariness will hang over the Chinese market. However, we think these shake-ups are signs that China might be a better place to invest over the next decade, but it will be a journey. There is no room for complacency. If we were to see wider intervention across all parts of the economy then we would probably consider withdrawal.
In my next blog I will look at what this might mean for Western companies selling to the Chinese consumer. Because it seems to me that COVID-19 and the shift in Chinese strategy has completely swung the consensus on globalisation. When I eventually leave my village, the world is likely to be that little bit smaller.
The Sharpe End, a multi-asset investing podcast from Rathbones, is now available. You can listen to the first episode wherever you get your podcasts or listen here.
