Despite being left out of the MSCI Emerging Markets Index during the latest review, China A-shares are still a good investment as they have fallen in value and offer more choice.
That is the view of the Citywire + rated Martin Lau, who manages several funds covering Asia, emerging markets and China equities at First State Investments.
Speaking to Citywire Selector, Lau said he had gradually increased the weighting of China A-shares in the $522 million First State Greater China Growth fund to around 9%.
‘For the last five or six years we have spent a lot of effort researching China A-share companies. When the valuation becomes attractive, when we have enough confidence on these China A-share companies, we just put more money into it.'
‘So the 9%, is a result of both the A-shares market falling and also the fact that we have done more research and become more confident on certain A-share companies,’ Lau said.
Lau said A-shares will eventually be included in the MSCI Emerging Markets index when current constraints on investment have been resolved. However, this may make A-shares more expensive.
‘Index inclusion is a negative, when a stock gets included into the index in a way people need to buy it and therefore valuations often go up and often get escalated because it is included in the index,' he said.
Lau said the A-shares market is trading at a premium of about 35% compared to the A-share market, but it offers opportunities that the H-share market cannot.
‘If you take a 10-to-20 year view, A-shares and H-shares will get closer in terms of valuation. The major reason for investing in the A-shares market is bottom-up, as more than 3,000 companies are listed on this market. The number of companies listed on the H-shares is a few hundred,’ he said.
Search for profit
In terms of sectors, IT is the biggest allocation in the fund at 33.3%, while he has a 4% holding in media company Tencent, which Lau said has the best corporate governance of all the internet companies in China. Lau said some internet companies, like search engines, offer more opportunities than others.
‘One challenge that we have when it comes to e-commerce in China is it is a very popular concept when it comes to consumers using them, but they are not actually making profit. The business model is about gaining market share and traffic. JD.com has never been profitable and we struggle to invest into those kind of companies,' he said.
‘However, what we have found is no matter which e-commerce company becomes successful, they need to pay for keyword searches on a search engine and they still need advertising. Baidu being the dominant player can actually capture the rise of e-commerce in a profitable way which is not the case for other companies.’
The First State Greater China Growth fund returned 2.3% in US dollar terms over the three years to the end of May 2016. This compares to a 5.2% rise by the MSCI Golden Dragon TR USD, its Citywire-assigned benchmark, over the same timeframe.