Practical analysis for investment professionals
26 November 2014

Where to Invest in China: Four Powerful Trends Long-Term Investors Can’t Ignore

“Long term.” This is a phrase that international investors have heard many times when it comes to investing in China. Veteran China investor Martin Lau, director, greater China equities, First State Stewart, apparently shares that sentiment.

I recently sat down with Lau in Hong Kong to discuss China investing and he could not contain his passion when the conversation turned to how long-term investors could profit from China’s growth. Lau sees four powerful trends that will play out over the coming decades:

1. Moving Up the Manufacturing Value Chain

For the last 20 years, China has competed on cheap labor and successfully made itself the global manufacturing powerhouse. Chinese manufacturers that follow this strategy, however, inevitably earn low margins and low returns on their investments. The recent rise in labor costs in China has rendered this strategy even less effective.

The next generation of successful manufacturing companies in China will be the ones that can move up the value chain. Six million fresh college graduates join the Chinese labor force annually, and their training improves every year. Lau believes that over the next 10 to 20 years, China will increasingly compete on the quality of this talent and move from low-end manufacturing to segments with higher value added.

“I don’t think China will have an Apple or Samsung anytime soon, but certain companies would manage to generate attractive growth by moving up the value chain,” Lau said. Lenovo seems to be one such example. The company started out assembling motherboards and also made white-labeled cheap PCs. It has since evolved into the largest PC maker in the world and developed a strong global brand. In addition to PCs, it also makes smartphones and provides services.

2. Protecting the Environment

It’s no secret that China has a pollution problem. Images of runners wearing gas masks in a recent marathon in Beijing are hard to forget. Lau expects the government to pay much more attention to the quality of growth rather than the rate of growth. Air quality and water quality will continue to dominate headlines and people’s minds.

One major environmental investing theme for the next 10 to 20 years is the change in China’s energy mix. Currently, coal supplies close to 90% of the nation’s energy due to its cost advantage. Increasingly, the government is pushing for natural gas, which is a much cleaner energy source. In terms of the current energy mix in China, natural gas is at roughly 3–4%. It is easily in the 10–20% range in Australia.

Lau thinks this shift could benefit certain industries, for example, the gas operators. “On the other hand,” he added, “you probably would be more careful if someone is involved in the coal mining industry.”

Martin Lau (l), director, greater China equities, First State Stewart, and Larry Cao, CFA

Martin Lau (l), director, greater China equities, First State Stewart, and Larry Cao, CFA

3. Growing Through Industry Consolidation

Lau argues that, barring telecom and oil, almost  every industry in China is fragmented, so there is a lot of room for consolidation as the economy matures. “The largest developer in China, Vanke, has a market share of 2%,” he said. “For the largest retailer in China, China Resources, the market share is like 8%. The largest cement company in China, Anhui Conch, has a market share of 12%. The comparable numbers can be as high as 50% in developed economies.”

On top of that, Lau thinks China is entering a structurally slower growth phase simply because of the law of large numbers. This exerts pressure for industry consolidation to take place. “Deferring property downturn will be a blessing in disguise for the good quality property companies, such as Vanke, if you take a 10-year view,” he said.

Lau and his team focus on quality and industry franchise. He added, “We really want to find the likes of Walmart, McDonald’s, or Coca-Cola. Those companies actually can do well in the slower growth environment through performing better than other companies.”

4. Aspiring to New Things and Experiences

In the past, the Chinese economy was driven largely by investments. Lau argues that growth for the next 10 to 20 years will be driven by consumption.

“The younger generation will have different aspirations,” he said. “They probably would want to go overseas to travel. They probably want to go overseas to study. They probably will be heavily influenced by the Internet, etc. I think their aspiration would be very, very powerful.”

First of all, this will benefit a lot of consumer and services companies — especially in the entertainment and travel industries. For the last 10 years, Chinese tourists and their shopping appetites have been a huge driver of economic growth in Hong Kong. Down the road, they might prefer different things. They may not be buying Gucci handbags. But their aspirations will grow in such meaningful ways that the companies satisfying these aspirations will develop.

The best example could be Internet companies like Tencent, the technology giant that took off with its social media software WeChat. “They are both popular and profitable, much like Google,” Lau said.

If you dabble with investing in China, have our discussions of these trends helped you gain some perspective? And old China hands — where are you invested? You are welcome to share your China investing experiences with us in the comment section below.

In case you missed it, don’t forget to read the first installment in the Investing in China series, “How to Invest in China: Five Myths Stock Investors Should Ignore.”

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: © Churchill

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About the Author(s)
Larry Cao, CFA

Larry Cao, CFA, senior director of industry research, CFA Institute, conducts original research with a focus on the investment industry trends and investment expertise. His current research interests include multi-asset strategies and FinTech (including AI, big data, and blockchain). He has led the development of such popular publications as FinTech 2017: China, Asia and Beyond, FinTech 2018: The Asia Pacific Edition, Multi-Asset Strategies: The Future of Investment Management and AI Pioneers in Investment management. He is also a frequent speaker at industry conferences on these topics. During his time in Boston pursuing graduate studies at Harvard and as a visiting scholar at MIT, he also co-authored a research paper with Nobel laureate Franco Modigliani that was published in the Journal of Economic Literature by American Economic Association. Larry has more than 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region. He started his career at the People’s Bank of China as a USD fixed-income portfolio manager. He also worked for US asset managers Munder Capital Management, managing US and international equity portfolios, and Morningstar/Ibbotson Associates, managing multi-asset investment programs for a global financial institution clientele. Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, South China Morning Post and the Wall Street Journal.

3 thoughts on “Where to Invest in China: Four Powerful Trends Long-Term Investors Can’t Ignore”

  1. Rahul R says:

    From the available signs and indicators, it seems China is the front running candidate for a potential major crash. And given its sheer size and impact on the global markets, no investor can afford to ignore this elephant in the room.

    Here are some facts that hint that China could be heading for some major trouble:
    1.Commodity prices are crashing!

    Iron ore prices have already crashed over 40% this year. They are now at a five-year low.

    Brent crude oil prices are down nearly 30%

    2.China’s wasteful investments

    China has been an investment-driven export-oriented economy. It has achieved high growth through continuous and heavy investments in infrastructure and new capacity creation. With the slowing global economy impacting exports, China’s economic model is no more sustainable.

    A huge portion of these investments is simply wasteful expenditure that is not going to generate revenues.

    3. Huge pile of debt

    China’s banks have lent about US$ 5 trillion over the last 6 years.

    *The People’s Bank of China announced a 40-basis point cut in one-year lending rates as well as 25 basis-point cut in deposit rates.

    Whenever the China crash happens, the consequences are going to be enormous for the entire global economy.

  2. Jie says:

    A daring government investing in infrastructure is better than democrats keep debating where to spend money. We are in recession just like the 1930s and by investing in public infrastructure and services America got over it, by expanding troops and starting war, Germany failed. Any thoughts? Yes, people now are as frustrated as back then, Australia needs better infrastructure and China needs a better economic strategy and the G20 just gave them a chance. That’s where I see opportunity.

  3. Savio Cardozo says:

    Hello Larry, when I first saw the title of the article I thought “Oh no, not another article on the investment opportunity in China – or how it is too late to chase opportunities in that country”.
    However on reading your article I thought it was easily the best article I have read so far in terms of both being easy to comprehend (for an investment neophyte like me) and comprehensive in its scope.
    Well done.
    I think #3 is the most interesting in its potential as rapid growth over the past few years will give a few industries a moment to pause, reflect, and consolidate.
    #1&4 are almost a given, for different reasons.
    I thought your analysis of #2 was interesting given that China has a terrible track record in this area. For all of our sakes (meaning fellow residents on this planet) I hope you are correct.
    Thank you again for an enjoyable and thought provoking read.
    Best of the season to you and yours this season and in the New Year

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