China is in the middle of a tightening regulatory cycle, which has elevated stock market volatility. These events have underscored our longstanding view on Chinese equities: it is a unique asset class that follows China’s regulatory cycles more than its economic cycles, which points to the need to invest in companies on the right side of policy change.
Regulatory cycles have been a feature of China’s development, and they have not impeded its phenomenal progress over the years. To a large extent, they reflect the course adjustments that officials undertook to balance economic growth with social harmony— an approach broadly characterized as “socialism with Chinese characteristics.”
Government interventions are not specific to China. Many of the issues it is trying to address, ranging from social inequality to corporate monopolies, are similar to those that have drawn regulatory action in the West. What makes China different tends to be its manner of policy execution. Geopolitical tensions have added urgency to parts of its agenda.
Against this backdrop, we examine the strategic goals that have shaped China’s latest regulatory moves. We also discuss our investment approach in light of the still-evolving policy environment.
We highlight three main takeaways.
- China is committed to becoming a “modern socialist country” achieving quality, equitable and sustainable development. This is the underlying thread uniting its regulatory actions under these broad objectives: common prosperity, national security, an orderly expansion of capital, financial stability and environmental sustainability.
- Investors should seek companies that could benefit from policy tailwinds, while avoiding those that look vulnerable to policy headwinds. Being selective is key. Regulations can affect companies within the same industry differently, and we are rigorous about individual companies’ alignment with China’s strategic agenda. Our analysts on the ground combine top-down perspectives with bottom-up insights to piece together an extensive view of a complex investment landscape.
- Chinese equities remain investable. In our view, to steer clear of China because of regulatory concerns is to give up potentially compelling exposures to numerous fast-growing, quality companies. Although regulatory scrutiny is an inherent risk, we monitor it closely and factor it into our research and portfolio management processes.
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What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.
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