China’s 20-year economic boom has boosted the wealth of its 1.3 billion citizens at the fastest pace worldwide and spawned some of the biggest companies in history. Foreigners earned less than 1 percent a year investing in Chinese stocks, a sixth of what they would have made owning U.S. Treasury bills.
The MSCI China Index has gained about 14 percent, including dividends, since Tsingtao Brewery Co. became the first mainland company to sell H shares to international investors in Hong Kong in July 1993. That compares with a 452 percent return in the Standard & Poor’s 500 Index, 322 percent in the MSCI Emerging Markets Index and 86 percent from Treasuries. Only the MSCI Japan Index had a weaker performance among the 10 largest markets, losing about 1 percent.
While China’s shift toward a market economy has lifted per-capita incomes by 1,074 percent and helped its companies raise at least $195 billion through stock sales in Hong Kong, investors with $695 billion say that corporate governance concerns, competition and state intervention have eroded returns for minority shareholders. Now, as China allows unprecedented access to its local capital markets amid the weakest projected gross domestic product growth since 1990, Aberdeen Asset Management Plc says valuations must fall further before it buys.
“China is a case in point that great GDP doesn’t mean a great stock market,” Nicholas Yeo, a money manager at Aberdeen Asset, which oversees about $322 billion worldwide, said by phone from Hong Kong on July 10. “The lack of quality in terms of corporate governance is one of the main reasons we find why companies don’t perform well over the long term.”
The MSCI China index closed 0.4 percent higher in Hong Kong, paring this year’s drop to 9.3 percent, after government data showed the economy expanded at a 7.5 percent pace in the second quarter, matching the median estimate in a Bloomberg News survey of economists.
The gauge of companies from Industrial & Commercial Bank of China Ltd., the world’s second-largest lender by market value, to PetroChina Co., the third-biggest energy producer, entered a bear market last month after falling as much as 22 percent from this year’s high in January.
The Hang Seng China Enterprises Index, a gauge of 40 H shares, has declined 18 percent this year. It’s up 138 percent, excluding dividends, since Tsingtao Brewery began trading on July 15, 1993. The Shanghai Composite Index of mainland-listed companies has dropped 10 percent this year and is up 143 percent during the past two decades.
The nation’s stocks have retreated amid a surge in money market rates last month that spurred economists at Goldman Sachs Group Inc. and China International Capital Corp. to predict GDP will expand 7.4 percent this year, which would be the weakest annual rate since 1990.
The ruling Communist Party is sacrificing short-term economic growth as it seeks to make the nation’s long-term expansion more sustainable, in part by curbing credit, Gary Dugan, the Singapore-based chief investment officer for Asia and the Middle East at Coutts & Co., said in a July 10 interview.
“With a new plan to rebalance the economy, we’ve got something of a cloud over” stocks, Dugan said.
China will increase a program for foreign funds to invest in its local financial markets to $150 billion from a previous limit of $80 billion, according to a statement posted on the China Securities Regulatory Commission’s website on July 12. The government restricts access to mainland markets through its Qualified Foreign Institutional Investor program, which has granted firms a combined quota of $43.5 billion as of June 26. That compares with the $3 trillion market value of locally-listed companies.
MSCI’s China measure trades for 9.3 times reported earnings, versus 16 times for the S&P 500 index, the biggest discount since September 2003, weekly data compiled by Bloomberg show. The MSCI Emerging Markets index has a multiple of 11.
“Sentiment is quite fragile” on China, Marco Li, a Hong Kong-based money manager at Manulife Asset Management, which oversees about $238 billion, said by phone on July 9.
In 1992, China’s Vice Premier Zhu Rongji approved the first batch of nine state-owned companies to sell shares in Hong Kong, then under British control. Tsingtao Brewery, founded by German settlers more than a century ago in the coastal city of Qingdao, was first among the companies, known as the China Nine, to meet international accounting standards.
Officials toasted Tsingtao Brewery’s debut on the Hong Kong stock exchange with beer instead of the customary glass of champagne as shares jumped 29 percent. The rest of the China Nine, including Sinopec Shanghai Petrochemical Co. and Maanshan Iron & Steel Co., sold shares in the following 12 months.
“For the first time in its history, China and its companies had access to the financial techniques and markets that enabled them to raise meaningful amounts of capital,” Carl Walter and Fraser Howie wrote of the H share market in their 2011 book “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.”
Another 167 companies have sold H shares in Hong Kong since then, including Beijing-based PetroChina’s listing in 2000 and ICBC’s in 2006, according to the city’s exchange. Hong Kong was handed back to China from the British in 1997.
China’s per-capita GDP climbed to $6,076 as of 2012 from $517 in 1993 as the economy expanded at an average annual pace of more than 10 percent to become the world’s second largest after the U.S., according to data compiled by the Washington-based International Monetary Fund. The growth in per-capita GDP is the fastest among 50 major economies tracked by the IMF and Bloomberg.
The nation’s stock market has produced gains for investors who picked the right times to buy and sell. The MSCI China gauge returned 680 percent from Nov. 10, 2001, when the country won entry into the World Trade Organization, through the index’s peak during the stock-market bubble on Oct. 30, 2007.
Consumer-related shares have delivered some of the biggest long-term increases as discretionary incomes grew. Tsingtao Brewery’s share price jumped more than 1,400 percent since it first traded 20 years ago. Great Wall Motor Co., the SUV maker with headquarters in Baoding, has advanced 1,660 percent since July 2008, making its Chairman Wei Jianjun Asia’s richest car executive.
“With transition of growth towards consumers you would want companies that leverage consumer spending,” Nader Naeimi, the Sydney-based head of dynamic asset allocation at AMP Capital Investors Ltd., which manages about $130 billion, said by phone on July 10.
Shares of Anhui-based Maanshan Iron have dropped about 37 percent since the end of 1993.
“China is one market if you buy a tracker or ETF, you are very much at risk,” David Gaud, a Hong Kong-based senior money manager at the asset management unit of Edmond de Rothschild Group, which oversees more than $157 billion, said by phone on July 11. “If you buy funds that are selective in their picking, we are able to grab the specific names in the private segments that are providing very, very solid returns.”
Gaud said he favors health-care, consumer and alternative energy stocks.
Chinese equity indexes have been weighed down with large positions in state-owned companies that tend to put political interests ahead of shareholder returns, according to Tony Hsu, a Shanghai-based money manager at Dalton Investments, which oversees $2.3 billion.
Under former President Hu Jintao, banks were directed to lend to local governments during the global financial crisis to boost growth, while artificially low fuel prices have hurt refiners such as PetroChina. ICBC, the Beijing-based lender, traded at a record low 4.9 times earnings last month, while PetroChina fell on June 25 to its lowest valuation since 2011.
More than 25 percent of China’s state-owned enterprises are unprofitable and their productivity growth has trailed that of private firms the past three decades, the World Bank said in February 2012.
China was ranked ninth out of 11 Asian countries for corporate governance as of September 2012 and had the biggest deterioration in the region since 2010, according to a survey by CLSA Asia Pacific Markets and the Asian Corporate Governance Association.
SOEs “primarily serve the interests of the government, frequently making decisions with little regard for return on investment,” Hsu said in an e-mailed interview on July 11. Hsu said he invests in Chinese companies run by entrepreneurs with large ownership stakes, while he’s selling short shares of state-owned companies.
In a short sale, traders sell borrowed stock, anticipating the price will drop so they can profit by buying back the shares at a lower price.
Earnings in the 137-stock MSCI China index have climbed about 5 percent during the past two years, versus 15 percent for the S&P 500, according to data compiled by Bloomberg. Profits in China are weaker in part because there’s too much competition, said Aberdeen’s Yeo.
“Any sectors that look interesting, you see a lot of players going in,” he said. “That has resulted in profits being competed away.”
China’s economic slowdown may further weigh on returns. The country’s exports and imports unexpectedly declined in June, while gauges of manufacturing fell. Finance Minister Lou Jiwei, speaking at the U.S.-China Strategic and Economic Dialogue in Washington on July 11, signaled the economy may expand less than the government’s 7.5 percent target this year and that growth as low as 6.5 percent may be tolerable in the future.
“This period of uncertainty can last a little bit longer than expected,” Mauro Ratto, the head of emerging markets at Pioneer Investments, which has about $216 billion under management, said in a phone interview on July 10. “It’s difficult to see a catalyst for the Chinese market.”