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Article03 Jan 2024

The China Dilemma: How Should We Position Chinese Equities in Portfolios?

Asia Pacific Strategy

China’s GDP has risen by almost 21 times since 1997, but its equity market index has barely grown much, rising only by 1.5 times over the same period.

Key Takeaways

  • China’s equity market has significantly underperformed over the last three years with an annual average return at around -17%. Investors are getting increasingly impatient to hold their China equities as a long-term investment portfolio.
  • Based on our data analytics and the latest academic studies, we establish certain salient facts of Chinese equity market over the last 25 years that are worthwhile to note:
    • First, China’s equity performance has little to do with the rapid rise of the Chinese economy. It is also the only major economy with equity market returns un-correlated with its GDP growth.
    • Second, China’s equity returns have been consistently lower than those in both developed and some emerging markets during the same period. For those Chinese stocks with dual listing status, the onshore price-earnings multiple often fetched a premium over those offshore-listed firms.
    • Third, the underperformance of Chinese equities can be attributable to sub-par earning-per-share growth as well as P/E multiples’ contraction.
    • Fourth, Chinese equity market has been in a trading range characterized by frequent bull/bear transitions, resulting in inconsistent return over medium-term holding periods. 
  • What are the key factors behind these unique features of the China’s equity market? Studies have found that current market regulations have allowed large shareholders to dominate corporate governance decisions, leading to overinvestment, low efficiency, and low cash flows. Inadequate regulatory enforcement has also allowed poor-performing firms to stay listed without fear of being delisted. Additionally, a lack of institutional investor culture discourages active investor participation in corporate governance of listed firms, either.
  • These features suggest that investors should take a thoughtful and alpha-oriented approach in positioning Chinese equities in their portfolio until important regulatory reforms can be undertaken to support a structural bull market.

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