This is the final blog in a 3-part series, reporting back on Redington’s exploration of the opportunities available in China A share markets. Tom Baird built the case for investing in on-shore China and Oliver Wayne followed up with the types of managers available. In this piece, I’m going to explore how investment styles fare in China A and give some thoughts on what might work in the future.
As we travelled around China meeting fundamentally orientated managers, it became clear to us that everyone we met was a growth investor. Different terminology was used of course. Even the self-styled “value investors” were at best growth-at-a-reasonable-price investors. Some thought more about the quality and sustainability of the growth (the one’s we like do this, exploiting the short termism of the locals). Some simply bought the highest growth names at any cost. The style spectrum is far narrower than you would find in US or global equity strategies.
What we couldn’t find were pure value investors. A Ben Graham margin-of-safety type who was hunting for the bombed-out bargains, an intrinsic value or even a ‘value + catalyst’ investor. We asked lots of people why this might be the case, and have spent time debating it amongst ourselves. We discovered it is partly down to time-horizon. Value relies on mean reversion which can take a long time to play out, and the local investors are too short-term orientated. It is also partly down to the risks associated with the cheapest names – many are the large SOEs or have very poor governance.
Barra Style Footprint of China’s SOEs (big, cheap with high leverage)
Source: ManNumeric, MSCI Barra
But of course, the whole reason value as a style works is because it takes advantage of such fears. Investors tend to overreact to bad news, creating the mispricing and thus the future outperformance. A market like China A should therefore be a great set-up for Value as 85% of the volume is created by pure retail investors who as we know as the most likely to overreact to events. We were constantly told by local investors that value wouldn’t work in China as it is a “growth market”, but the big quant firms disagree. Their back-tests suggest Value works, really well:
Here you have a market where a well-known risk premium is under-exploited but appears to work really well.
So how do we access it?
Those big quant firms are actually a good place to start. Many are now taking their well-honed models into China A and launching products as the data quality has improved markedly over recent years. Value combined with other factors appears to work very nicely, and with the 4000 or so stocks on offer (via QFII or c.1500 of the largest via Stock Connect) there is more than enough breadth for quant to do its stuff.
There are two schools of thought emerging within the quant community.
- Do you take your existing alpha model and point it at China A, even though the market has behaved very differently to other emerging markets historically? Traditional 12-1m Price Momentum for example hasn’t worked well in China, and most quants include this factor, or a variant of it.
- Or, do you adjust your model to account for that, and to take advantage of the variety of different data sources on offer out of China that you can’t get elsewhere? The quants that have gone down the latter route appear to be better set-up to invest in China right now. The former group argue that as China A opens up it will start to behave more like other markets, and their model will be the right way to go.
Lots of decisions to make, but there are now a few interesting ways of accessing China A. For a multi-manager solution, a multi-factor quant blended with a quality-growth fundamental investor could be the best of both worlds.