Through the course of PEI’s ongoing manager due diligence process, China has been a recurring topic of conversation, as managers follow the country’s transition from an investment driven economy to a consumer driven one, and assess the implications of this transition for China itself and its emerging market neighbors. As the country’s economic transition has progressed, its growth rate has come under significant pressure. These growing pains, along with the country’s rapid rise in debt since 2008, have contributed to a prolonged downturn in commodity prices as China, once the top importer of commodities, now faces reduced demand for many commodities. The sell-off in commodities and China’s growth concerns in general have taken a toll on other emerging countries, as import demand remains uncertain and the larger issue of China’s status as a trade partner moves to the forefront. Many fund managers have been revisiting their exposure to the country, re-evaluating the impact China may have on the global economy and how to best position funds as a result of the volatility in the region.
Though China has been a major source of volatility since the start of the New Year, conversations with fund managers have indicated that most do not see it as the first pillar of a global economic meltdown or a “Lehman-like” event. The general view is that the slowdown in China’s growth rate has been well telegraphed for years and is not a surprise event. However, renewed uncertainly as to the rate of the deceleration of China’s growth has generated some concern. As fund managers maneuver through the process of re-visiting exposure to China, to either gain comfort or highlight issues, they are also taking a larger look at the broader emerging market world. On this note, feedback highlights a consensus opinion: that emerging market countries are likely to be a major source of global growth over the long-term. While comments center around emerging market valuations as “cheap” and the existence of long-term investment opportunities, managers caveat these comments with the idea that near-term challenges abound, likely leading to a bumpy road ahead for emerging market investments. Ultimately, most of our managers believe that the People’s Bank of China and the Chinese government have the tools to engineer a bumpy landing for the country’s economy or what some are calling a “stall-out” event. However, at this point they are holding off on increasing exposures to China and the broader emerging market world given near-term hurdles.
Given the viewpoint that the slowing Chinese economy is not Armageddon, the thoughtful process turns to how fund managers are positioning their portfolios to account for China’s slower growth and it’s more consumer-oriented focus. As such, PEI’s more recent due diligence efforts have focused on this topic, with most managers indicating that although the overall Chinese economy may be slowing, pockets of investible opportunities remain. More specifically, fund managers are focusing their investments on companies that are still able to take share in their respective markets despite China’s slowing economy. This angle is leading to a focus on the technology and consumer sectors. Ultimately, managers are looking to invest in innovative companies that are introducing differentiated products likely to succeed as the Chinese consumer becomes more sophisticated.
As fund managers continue to assess China’s trials and tribulations and work through the process of evaluating exposures to both the country and broader emerging market regions, they acknowledge that although near-term obstacles abound, opportunities remain. There appears to be agreement that China’s growing pains are not likely to lead to a global economic crisis, however most managers still remain cautious about increasing allocations to both China and emerging market investments in general. Those mangers that are adding at the margin have indicated they are more inclined to add to existing China holdings given an established level of conviction; waiting to delve into new names until there are signs of currency stabilization and clearer signals from the Chinese government regarding expectations for the country’s economy.