China’s crackdown is not a revolt against capitalism

I recently wrote an article for FT Adviser which looked at how China’s regulatory crackdown had negatively impacted emerging market investment funds during July. You can read the article here.

The developments in China are interesting and not, as some in the West may surmise, a revolt against capitalism

The concerns of Chinese regulators are focused on the big tech companies. They are concerned about their market power and alleged anti-competitive practices; control of consumer data more generally; education quality; the fair treatment of workers and getting kids off screens. These concerns are not exclusive to China, they mirror those of regulators (and parents) around the world.

Two distinct Chinese equity markets

As an investor, it’s important to understand that there are two distinct Chinese equity markets: the domestically listed (onshore) A-share market and the offshore markets which include companies listed in Hong Kong and the US.

It was the offshore market that was particularly hard-hit in July, down almost 14% in dollar terms over the month versus the 5% fall of the domestic A-share market. The offshore market then saw further falls in August before closing more or less flat for the month, with the A-Share market up 1%.

The regulatory squeeze began last November as regulators torpedoed the initial public offering (IPO) of Ant (Alibaba’s fintech business). This would have been the world’s largest ever IPO, so the last-minute obstruction by the government was significant. Share price jitters continued into 2021 as China initiated a number of investigations into the ‘anti-monopolistic practices of big-tech’.

Things really came to a head in early July, however, as China suspended app downloads of newly US-listed Didi Chuxing (China’s ‘Uber’), citing data sharing concerns, which caused its shares to plunge.

Next to feel the force of the regulator were the formerly high-flying Chinese listed education companies with the announcement they needed to become non-profit organisations because of fears that their high costs were one of the reasons putting off Chinese parents from having more children.

Tech companies such as Tencent and Alibaba continued to fall and were joined by food delivery company Meituan, after it received criticism from the regulator, calling for improved conditions for its drivers and other workers. The domestic A-Share market fared much better in terms of performance, no doubt because it is a lot less concentrated (the top 10 makes up only 20% of the MSCI China A Onshore index vs over 43% in MSCI China).

As a result, portfolios tilted towards the A-Share market – as ours were – fared better than those focused on the harder-hit offshore market.

A knock-on effect?

It’s our view that domestic China offers a better opportunity for growth of the two markets but also more opportunity for active managers given it is less well researched. It also offers more scope to diversify given its lower weighting in most emerging market funds.

With China taking a harder line against the giant corporations that impact fundamental areas of society, it may be wise for investors to question whether there could be knock-on effects outside China if other regulators follow suit.  Global giants elsewhere in the world (that are often very expensively valued) could well be vulnerable to some form of regulatory push-back too.