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China is a rare place where value investing isn't a bad bet

[HONG KONG] The value trade is finally having its day in the sun - in China.

While chasing bargain stocks in overheating markets around the world has been a losing strategy, it's a surprisingly successful play in Shanghai. A gauge of the city's big companies with the lowest valuations is up 12 per cent this year, taking it to a record relative to the benchmark, as banks and property developers surge. It fluctuated on Monday even as a selloff in global equities intensified.

It's not for the fainthearted. Mainland shares just had their worst week since 2016 and are about twice as volatile as those elsewhere in the world, with retail investors dominating what is still a largely speculative market, according to Ken Wong at Eastspring Investments.

"The A-share market is not always rational, which makes it difficult if you're looking to play a specific theme," said Mr Wong, a Hong Kong-based fund manager at Eastspring, which manages about US$170 billion.

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"That's an opportunity for us - there's bound to be that diamond in the rough."

The value versus growth split is another way to dissect the theme that's dominated China's US$8 trillion equity market for more than a year: investors favoring cheap large-caps, often stodgy state-owned enterprises, over the smaller companies that are seen as having the most to lose from the nation's deleveraging campaign.

To be sure, the Shanghai value index is heavily skewed towards financial firms, which make up about two-thirds of its market cap and have soared this year. Among the biggest of its 60 members are Industrial Bank and Agricultural Bank of China, which trade at discounts of at least 40 per cent relative to the Shanghai Stock Exchange 180 Index, according to data based on projected earnings.

Stock pickers will continue to do well in China as long as concern over the country's economy or its financial system don't flare up again, according to investment risk-management firm Axioma. Pension funds and insurers, which are more likely to use quantitative strategies, will also increasingly take part in the domestic market, Axioma says.

"Both large caps and value are attractive characteristics more aligned with the investment horizon of institutional investors," said Olivier d'Assier, Axioma's head of research for Asia Pacific.

China is a rare bright spot in the world of value investing, where investors try to hunt out stocks that are too cheap relative to their earnings, assets or to the income stream they provide. Globally, waiting for the momentum trade to fizzle has proven painful, as evident in last year's outperformance of pricey Internet and technology shares The divergence has been so acute that the MSCI All-Country World Value Index now trades at the lowest level since 2000 relative to its growth counterpart. Eastspring's Mr Wong says he's taking advantage of the gap in China, eyeing cheap onshore shares of banks, energy firms and phone companies.

"It gets to a point where it's going to be much harder for investors to keep paying such a high premium on these high-growth companies," he said. "People will chase value when it's scarce, and they're starting to warm up to the A-share market."

BLOOMBERG

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