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US funds not bailing on China yet amid free-fall in stocks

[NEW YORK] After almost a month of watching Chinese stocks in free fall, some US fund managers are buying shares at what they consider distressed prices, though they predict continuing volatility - and perhaps more declines - ahead.

The Shanghai Composite Index's sell-off took a break on Thursday as government efforts to prop up the market pushed shares up 5.8 per cent, the biggest one-day gain in six years.

The Shanghai Composite has tumbled by about a third since mid-June, wiping out about US$3 trillion in market value and ending a rally that had previously seen the market double from its June 2014 low. In response, Beijing has cut interest rates and stopped the trading of thousands of stocks, preventing some shareholders from selling their positions in hopes of ending the downturn.

The measures have instead helped spread the rout to the Hong Kong-based Hang Seng index, whose listings of so-called H share companies are largely owned by foreign investors and trade at lower valuations, fund managers said.

"You've had some misguided efforts to cushion the selloff and that's ultimately led to the unintended consequence of making the situation worse," said Charles Wilson, co-portfolio manager of the US$2 billion Thornburg Developing World fund who has been adding to his positions in Chinese consumer, internet and utility stocks over the last few days of the selloff.

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The Hang Seng index fell 5.8 per cent on Wednesday, its biggest decline so far this year, before rebounding by 3.7 per cent on Thursday. The index is still up 3.3 per cent for the year to date, while the Shanghai index is up 14.7 per cent over the same time.

Reuters contacted several prominent mutual fund managers, including the US$8.7 billion T Rowe Price Emerging Markets Stock fund, the US$1 billion Columbia Global Equity Value fund, and the US$76 million Morgan Stanley Global Opportunity fund, who all declined to comment. It's the widest selloff in China, home of the world's second biggest economy, since the global financial crisis of 2008.

While it is unclear what will happen when Chinese markets resume full trading, most fund managers and analysts expect there to be further losses as sell orders move through the market.

Beijing has moved to curb new listings and extracted promises from fund managers and brokerages to buy at least US$19 billion in stocks to provide support for blue chip shares. In addition, the China Securities Finance Corp, the country's official margin lender for brokerages, has raised its capital base to 100 billion yuan from 24 billion yuan, in order to stabilize markets.

On Wednesday night in China, the securities regulator ordered shareholders with stakes of more than 5 per cent from selling shares for the next six months in a bid to halt the plunge in stock prices. This largely does not affect US investors, as there are no institutional funds that own more than 5 per cent of any Shenzen or Shanghai-traded issue.

While US investors say that they remain largely bullish that consumer spending will expand and the fallout from the stock market crisis will be limited to the relatively small upper class of speculators that own A shares, every portfolio manager interviewed by Reuters noted that additional policy changes by Beijing could alter their outlook. At the same time, fund managers like Wilson say the volatility and selloff is making the Chinese market more attractive for long-term investors, even if the market has not hit bottom yet.

Emily Alejos, portfolio manager of the US$20.8 million Nuveen Tradewinds Emerging Markets fund, noted that companies that focus on domestic consumption in the country are trading at enticing prices.

"For a long-term investor, some of these valuations (in H shares) are quite compelling," she said, adding that the steep declines are not affecting her outlook for the Chinese economy because the losses in wealth among the relatively small percentage of Chinese who own stocks are not likely to dent the country's expected GDP growth of 7 per cent.

Frederick Jiang, co-manager of the US$724 million Ivy Emerging Markets Equity fund, echoed that sentiment. "If you look at the Chinese market, it's a bipolar market with the high growth A shares trading at very expensive valuations and the H shares trading below 10. It's probably the cheapest major market in the world," he said.

Mr Jiang, whose fund has large positions in the H shares of Chinese companies including Fosun International and Bank of China Ltd, said that he did not see any evidence that the booming stock market affected personal consumption levels in China apart from housing prices in major cities and thus expects the effect of the market decline on spending to be muted.

High levels of margin trading coupled with a frenzy among Chinese investors for A shares - those small and mid-cap companies whose ownership is largely restricted to domestic owners - sent valuations above 50 times earnings this year. H shares, by comparison, trade at approximately 10 times earnings.

To be sure, finding true price to earnings ratios and other valuation metrics for Chinese companies can be difficult given the scant accounting laws and other forms of investor protection Stretched margin levels are one reason why Robert Bao, portfolio manager of the US$2 billion Fidelity China Region Fund, is most worried about China's brokerage sector.

"What does this mean to their earnings and balance sheets?" Mr Bao said. "And they're very levered to the stock market." Yu Zhang, lead manager of the US$5.9 billion Matthew Asia Dividend fund, said that the market decline could lead to more monetary easing in China, which in turn would boost the appeal of high-dividend paying stocks such as insurance companies.

"We're not sure how long this volatile period will last, but to me the medium- to long-term outlook for China is still trending up," he said.

The market plunge comes at a time when China had become an increasingly popular option for both retail and professional investors in the US.

Retail investors have sent US$3.4 billion to China-focused mutual funds and ETFs for the year to date, the largest amount since 2009, according to Lipper data.

International funds, meanwhile, now have an average of 3.2 per cent of assets invested in China, up from 2.2 per cent in 2012, while US large cap funds that own Chinese stocks have an average of 2 per cent of assets in Hong Kong listed companies, up from 1.3 per cent in 2012.

Even as he expects those fund inflows to reverse course, Mr Jiang, the Ivy fund manager, said that Beijing still has further policy moves to make in order to stabilize the market. "When your house is on fire, you find a way to put it out," he said. "Then you can talk about the market finding a natural bottom."


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