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Asia/China equities: Regulatory risks come to the forefront

The article highlights China’s latest regulatory landscape and recent market moves.
30 July 2021
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    What’s new

    • Since the start of the year, Chinese policymakers have reiterated their desire to normalise countercyclical macro policies, as well as to tighten regulations on big internet and financial technology companies amidst other industries. The regulatory campaign has intensified in recent weeks, triggering a sell-off in the shares of Chinese technology, education and food delivery companies. The regulatory concerns also appear to have triggered a broad-based reassessment of Chinese equity risk premium
    • In our view, there is a clear shift in policy priority to balancing growth and social equality, national security and supply chain security, and the policy agenda is likely to tackle secular risks such as income inequity, slowing population growth and eliminate extreme poverty in the coming years
    • We believe the Chinese governments wants to balance out the growing or even monopolistic influence of major tech giants in the key areas such as the market place, social media and finance, allowing more competition and giving consumers and small businesses the tools they need to succeed and grow. For instance, the country’s two biggest tech giants are facing pressure to open up their systems and market place to allow easier transfer of money by allowing each other’s payment tools on their online platforms
    • We expect the regulatory overhang and headline risk for targeted sectors to remain in place in the second half of the year. This not only increases risk premium for equity valuations but also impacts the fundamental earning outlook of the targeted companies/sectors
    • Investors as well as the listed companies themselves will need to wait for more regulatory implementation details to assess the earning impact and future growth outlook. We don’t think the regulatory risks are completely priced in yet, especially since the regulations are now more broad-based. Currently, we do not see possible positive catalysts in short term that could improve sentiment significantly amidst the regulatory risks around the tech industry in particular
    • However the tech/internet industry remains an important driver of China’s long term growth and the government is not trying to stop the industry from flourishing but promoting efficient and fair growth while containing systemic risk. We believe valuations within the sector could recover once uncertainty is removed. Issues that are worth watching out for are data safety, VIE structure and a balance between profit-making and social responsibility

    Recent market-moving regulatory changes in China

    Date Regulatory guidelines
    Dec-2020 The State Administration for Market Regulation (SAMR) initiated anti-trust investigation of ecommerce companies for potential monopolistic practices
    Mar-2021 SAMR announced penalties on five major companies that were engaged in community buying business
    May-2021 Local government requires businesses to cover basic social insurance for full-time food delivery riders
    Jul-2021 The State Council tightened rules for overseas listings
    Jul-2021 SAMR issued draft rules on violation of Price Law, for selective pricing for the same product
    Jul-2021 SAMR issued documents requiring food delivery platforms to guarantee minimum income, insurance etc
    Jul-2021 Chinese regulators asked an online music company to give up its exclusive music streaming rights
    Jul-2021 The Ministry of Education issued rules to curb some big education and tutoring companies to raise funds through public markets

    Source: Chinese government, Morgan Stanley, JP Morgan, HSBC Asset Management, July 2021. Investment involves risks. Past performance is not indicative of future performance. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Asset Management accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative purposes only.
    This publication is intended for Professional Clients and intermediaries’ internal use only and should not be distributed to or relied upon by Retail Clients. The information contained in this publication is not intended as investment advice or recommendation. Non contractual document. This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Asset Management accepts no liability for any failure to meet such forecast, projection or target.

    What’s the impact on our China and Asia ex-Japan equity portfolios

    Chinese equity strategies:

    • Our Chinese equity strategies have underweighted internet names since March given growth-to-value rotation in the market and the regulatory overhang. We have significant underweight positions in US listed ADRs and all US ADRs we hold have already been secondary listed in Hong Kong. We expect the negative sentiment around US ADRs to continue in the short-term, however we see relatively little impact on the onshore Chinese equity market given its limited exposure to internet stocks
    • Similarly within the education sector, our Chinese equity strategies began to trim down their positions in January amidst high valuations. Close monitoring of the changing regulatory landscape also allowed us to exit our positions well before the market correction. This highlights the importance of active management, flexible allocation and bottom-up stock selection, particularly while investing in a higher policy risk environment
    • Going forward, we will continue to overweight the information technology sector, preferring companies in the semiconductor and technology hardware and equipment industries. Semiconductor shortage has broadened to the downstream channel, causing tight supply/demand conditions in automotive, consumer electronics and industrial sectors. This means the pricing power of manufacturers will continue to increase. We also believe that chips powering autonomous driving systems will be the next focus area after smartphone chips in China. The sector has relatively fewer regulatory risks and is likely to be more resilient when growth stocks get de-rated or as the risk-premium of tech stocks increases

    Asia ex Japan equity strategies:

    • China has been the biggest underweight in our larger cap portfolio (8 per cent underweight vs the benchmark as of end June, now 12 per cent underweight). We have also trimmed exposure to the market in our small cap portfolio even though the recent regulatory moves are more targeted towards larger companies
    • We don’t believe the government would want to impair the operations of these big private enterprises in the long term because of its focus on domestic / homegrown innovation. However regulatory noise would remain a headwind and could potentially increase the risk premium assigned to these businesses
    • We are cognizant of the uncertainties that lie ahead and believe the current volatility is an opportunity for us. For now, we remain stock focused, and would at the margin be inclined to add very selectively on a bottom up basis after assessing the risk-reward opportunities of individual business models
    • Taking advantage of our diversified regional portfolio, we have assumed bigger overweight positions in internet growth stocks in Korea and South East Asia and are seeing some positive impact from this diversification strategy

    HSBC China equity portfolio - active sector weightings

    HSBC China equity portfolio - active sector weightings

    HSBC Asia ex Japan equity portfolio - active geographical weightings

    HSBC Asia ex Japan equity portfolio - active geographical weightings

    Source: Bloomberg, HSBC Asset Management, data as of June 2021

    Investment involves risks. Past performance is not indicative of future performance. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Asset Management accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative purposes only.

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