A perspective on recent regulatory developments in China and the impact on the Emerging Markets strategy
July 28, 2021
Due to the recent events on regulatory tightening in China and subsequent market declines, the following are Manulife’s Emerging Market Equity team’s views on these actions and their implications to the strategy.
The scale of regulatory changes in China impacting the internet, fintech, education, healthcare and the capital markets escalated dramatically over the weekend following the announcement of harsh measures affecting the education sector. The imposition of regulation to forbid institutions to raise funds in capital markets and to become not for profit organizations, together with stringent restriction on the scope of their activities, has led to widespread concern about the extent of further action on other sectors perceived to be misaligned with government policy. The severity, suddenness and opaque nature of these developments has triggered sharp falls in share prices in China’s growth stocks this week.
This signifies the need for a broad reassessment of China risk, in the context of an understanding of the long-term drivers of policy direction from the Chinese government. Our response has been to reduce our exposure to Chinese growth stocks in anticipation of a protracted period of uncertainty and volatility. Until we have clearer evidence of a stable regulatory environment enabling us to understand the implications for growth, margins, and profitability, we expect to remain cautious in relation to exposure to the new economy. However, growth in China is not restricted to the internet. Areas of focus will instead concentrate on companies more clearly aligned with national objectives in the A share market where foreign ownership is low and domestic growth drivers are intact, such as consumption and the transition to the green economy.
China’s underperformance in 2021 is a consequence of ongoing regulatory tightening on top of contra cyclical macro tightening. In retrospect, the high-water mark of an era of relatively relaxed regulation on the new economy, which was dominated by remarkably successful innovators such as Tencent Holdings Ltd, and Alibaba Group, was marked in October 2020 by the unexpected postponement of the Ant Financial (Ant Group) IPO. Since then, we have observed intensifying pressure as government priorities have been reset around the requirements to develop a modern socialist economy which places prime emphasis on the importance of ‘common prosperity’, reducing inequality and greater social responsibility by corporates. The aims of tighter regulation have been to reduce monopoly power and corrupt practices, to restrict the exploitation of personal and national security data by the private sector and foreign parties, to widen access to national champions by local investors, and to realign business models with national development goals. The government is acting to reduce risks relating to financial and social inequality by reorienting business owners to national objectives.
This has potentially significant implications for prospective returns which are, as of yet, unclear. It does not, in our view, however, imply a war against capitalism as some have suggested. The private sector after all, accounts for as much as 90% of urban employment. A shift to higher value-added activities supported by innovation in the private sector is essential to achieving the long-term aim of becoming a high-income society by 2035. We believe everything that has been achieved in recent decades in terms of growth and wider prosperity will not be put at risk, but the days of easy regulation and profits are gone.
Past regulatory clampdowns do provide some indication of the path ahead. Typical duration lasts 12-18 months before the business and investment community develops a clear sense of how to operate in the new environment. Further regulation in relation to data, cybersecurity and healthcare platforms will be forthcoming. This further reinforces our immediate caution. In short, even though we have increased our cost of equity in our modelling, it is too early to assume that risks in China are priced in.
Importantly, this is a country specific regulatory story, and does not have wider fundamental implications for growth and technology sectors outside of China. These represent a compelling multi-year, deepening growth opportunity across a wide range of emerging markets in Asia, Latin America, and Eastern Europe, which the Emerging Markets strategy is effectively positioned to exploit.
The opinions expressed are those of Manulife Investment Management as of July 28, 2021 and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Manulife Investment Management disclaims any responsibility to update such information. Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.
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