China investors learning how to profit from Xi's new capitalism

[BEIJING] Over the past year, President Xi Jinping has ended China's days of limitless private sector-growth in favour of state-directed "common prosperity". While that's made life more difficult for investors, they are slowly learning how to cash in.

Before last year, owning shares of China's fast-growing private enterprises proved a winning strategy. At its peak in February 2021, the MSCI China Index rose almost 380 per cent since the depths of the global financial crisis, beating a benchmark of global equities by about 140 percentage points. Buying Chinese firms listed in the US was even more profitable, with the Nasdaq Golden Dragon China Index rising more than 670 per cent in the period.

That all changed with Xi's crackdown on the nation's tech giants, prompting the MSCI China last year to lag its global equivalent by the most since 1998. Internet bellwether Tencent, which returned more than 109,800 per cent for investors from its 2004 initial public offering, has lost about its market value - or US$478 billion - since hitting a record high. The Hang Seng Tech Index is down more than 45 per cent in the past year.

To China's leaders, this is all a success: Last weekend during the annual session of the National People's Congress, Premier Li Keqiang hailed the prevention of "unregulated expansion of capital" as one of last year's top achievements.

In their eyes, it's more important than ever for the private sector to be in lockstep with the Communist Party, particularly as economic growth slows to a 3-decade low in an increasingly volatile world.

Beijing is becoming more deliberate about which sectors to promote as resources shrink and it seeks to cut dependence on the US due to rising geopolitical tensions - a calculation exacerbated by Russia's war with Ukraine.

The population is aging and labour productivity is weak, while old debt-dependent growth drivers like the property market must be replaced for China to avoid a financial crisis.

"China isn't growing at 10 per cent anymore - it can't afford to have a private sector that's exploring," said Alicia Garcia-Herrero, Natixis chief Asia Pacific economist. "When China needs to choose, social capital becomes essential. The private sector serves the purpose designed by the party."

Still, there's money to be made for investors who carefully read the messages out of Beijing. Authorities in recent months have rolled out cash subsidies for high-end manufacturing, affordable housing and sustainable energy in a bid to accomplish Xi's goals of technological self-sufficiency, income equality and sustainable growth.

A gauge of so-called Chinese red chips - or Hong Kong-listed Chinese companies with significant state control - climbed 20 per cent in 6 months. Greenlighted industries can quickly overheat: the top performing equity funds in Asia last year all invested heavily on Chinese renewable energy stocks after Xi pledged in late 2020 that China would hit carbon neutrality within 40 years. Some returned more than 40 per cent.

Battery maker Contemporary Amperex Technology Co rallied 2,650 per cent in just over 3 years to become one of China's most valuable companies.

Venture capital firms poured at least US$8.7 billion in so-called cleantech startups last year, up from US$5.6 billion in 2020, according to research firm PitchBook.

Sequoia Capital, GIC and Primavera Capital recently gave more than US$1 billion to Shanghai-based Envision Group, which produces wind turbines and batteries.

China's green bond issuance quadrupled to US$83 billion in 2021, according to Bloomberg NEF calculations. The official stamp of approval is helping a new generation of startups in strategically important sectors such as robotics, quantum computing and semiconductors.

These "little giants" are selected under a government programme that's received the personal blessing from Xi, and the initiative will expand this year to almost 8,000 companies.

Investment spending on these new infrastructure projects is expected to grow 12 per cent this year, according to Goldman Sachs Group. Another focus for Beijing is food security, an increasingly pressing topic as the war in Ukraine sends grain prices rocketing.

China's biggest technology companies are being encouraged to invest in rural e-commerce: Rural Taobao, an initiative launched by Alibaba Group, links farmers directly with urban consumers via an online marketplace. Rival Pinduoduo, which also has a vibrant rural e-commerce operation, has pledged US$1.5 billion in profits to Chinese farmers.

'Next investment opportunity'

China is also transforming housing to clamp down on speculation. The government plans to build 6.5 million low-cost rental apartments by 2025, making up an estimated 26 per cent of new home supply at as much as 30 per cent below the market rate.

The country's top financial regulators in early February moved to exempt low-cost rental housing projects from curbs on property lending, with brokerages calling it the "next investment opportunity" for real estate firms.

On Mar 4, the banking regulators issued a notice to address the financial needs of what they called "new citizens", an estimated 300 million new migrant workers who haven't obtained permanent residency status in the cities where live. Local governments are expected to provide affordable rental housing, while banks are to underwrite mortgage loans.

"Ultimately the goal is to achieve a more sustainable model of growth that's less reliant on debt and property," said Larry Hu, an economist at Macquarie Capital in Hong Kong. "This will be good for China. But common prosperity can't just be a campaign - it must be a gradual process. You can't do it all in one go or else you risk scaring off investors and destabilising the economy."

Some global investors are endorsing Xi's new model of capitalism. Ray Dalio, the founder of the US$150 billion investment firm Bridgewater Associates, recently praised China's common prosperity drive and urged countries including the US to follow suit.

Stephen Jen - co-founder of Eurizon SLJ Capital and former head of currency research at Morgan Stanley - said Xi's plan will ensure long-term stability and socially responsible economic growth. There are "huge opportunities" if investors remember the party is in charge, said Hugh Young, Abrdn's chairman for Asia in Singapore.

Others are not so convinced. Billionaire philanthropist George Soros, who was upbeat on China's economy in the aftermath of the global financial crisis in 2009, criticised Xi's policies in January and even said his leadership was under threat - a claim dismissed by authorities in Beijing.

"Beijing will first have to convince international investors that common prosperity is far more powerful and effective than western models of capitalism," said Garcia-Herrero from Natixis. "That's a major uphill battle for China." BLOOMBERG