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Forget zombies – Chinese vampires are lurking, warn Schroders duo

Forget zombies – Chinese vampires are lurking, warn Schroders duo

Investors shouldn’t fear ‘zombie’ companies in China but rather the emergence of ‘vampire’ institutions draining resources for superficial growth, Schroders’ Robin Parbrook and Lee King Fuei have warned.

The duo, who co-run the $2.1 billion Schroder ISF Asia Total Return fund, said China is drawing increased comparisons with 1990s Japan due to the number of inefficient companies being kept afloat.

However, the pair said the slowdown in credit growth that many economists have highlighted is overdone and a more pressing concern could be emerging.

‘What we are seeing is not zombie SOE companies borrowing but perhaps something more worrying – what Jon Anderson of Emerging Advisors has labelled “vampires”,’ the duo said in an investment update for the fund.

‘This is local government entities borrowing, probably to fund all the opaque PPP-style partnerships they have set up to build the infrastructure projects required to keep the great Chinese ship afloat. In the end these are debts, we think, will end up fairly and squarely on the government’s balance sheet.’

While the pair said the level of real Chinese government debt is set to increase, as long as there is no sudden capital flight they believe the much-forecasted crisis for China will fail to materialise.

‘On current policies it is possible, we believe, that within five years overall Chinese debt to GDP could be over 350% and real government debt to GDP is close to 150%. Whilst of course worrying, as Japan has proved contrary to your writer’s expectations 15 years ago, as long as there is no rapid capital flight there is no reason to think this triggers an immediate crisis.’

Positioning portfolio

China currently makes up only 14.6% of the fund's exposure, with Hong Kong accounting for 24.7% of the fund’s country allocation. Parbrook and Fuei said they expect to add to Hong Kong, while trimming ASEAN exposure further.

‘We have been quite active in reducing some of the remaining ASEAN positions mostly due to high valuations and on-going worries about the poor structural outlook for some of the ASEAN economies.

‘On the other hand we are seeing increasing value in Taiwan and Hong Kong which appear to have been caught in the China “it’s all going horribly wrong” downdraught and this is throwing up some interesting opportunities.’

The Schroder ISF Asian Total Return fund lost 0.4% in US dollar terms on a three year basis against an average manager return of 1.3% over the same timeframe.

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