The growing importance of the Chinese economy may be one of the most misunderstood phenomena among investors of the past decade. And while fund managers may talk about China exposure, Rathbones’ head of multi-asset investments David Coombs said it is more complicated than making an allocation according to a benchmark.
China index returns have underperformed the developed markets-focused MSCI World over the past 10 years, but the pace of growth in the Chinese economy has outstripped that of its financial crisis-stricken Western counterparts.
Over the past 10 years the MSCI China index has made a return of 119.91 per cent compared with a 242.68 per cent gain for the MSCI World index, in sterling terms.
Performance of indices over 10yrs
Source: FE Analytics
Rathbones’ Coombs – speaking at the 10th anniversary of the Rathbone Multi-Asset Portfolios – said that Chinese growth has been one of the biggest themes of the past decade and would continue to be for the next 10 years.
As such, he said it would be wrong to under-allocate to China, particularly given its growing importance to the global economy.
“If you think about how it normally works in the multi-asset world, you have X amount of UK equities, European equities, US equities and emerging market equities,” he said.
“China is a sub-set of emerging market equities, okay? That’s what MSCI tells us and MSCI are gods, obviously, and tell us how we should invest. I think, fundamentally, that makes no sense.”
Coombs said such an approach was nonsensical because China’s consumer market has grown to rival that of the US and is an attractive one for many businesses.
“Almost every company that you talk to when they’re looking at capital allocation decisions, you tend to find China and US head those discussions because they’re easy to do business in,” he explained.
“When you ask them about Europe, they’re always very polite but ultimately they find Europe difficult to do business in. Why? It’s fairly obvious: lots of different cultures and different rules still, despite the EU,” Coombs said. “It’s a harder route to market. 
“We need to invest where companies’ customers are, not where they’re listed.”
He added: “So for the Chinese economy, which is huge, it doesn’t make sense to only have 5 per cent of your equity portfolio [there]. It’s such an important economy.”
As such, Coombs (pictured) – lead manager of the £441.9m Rathbone Strategic Growth Portfolio – said there are two ways that the firm aims to get exposure to the country.
The first method is directly via Chinese companies, which are mainly invested in domestic-facing companies since the trade war issue surfaced.
One example of a domestic name that the team likes is Luckin Coffee, a company founded in Beijing in October 2017, which has become the second-largest coffee chain in China behind market leader Starbucks.
The chain took market-share because of a service which allows customers to order and pay from their place of work and collect when it is ready, or pay extra to have it delivered. As such, the business is tipped for an initial public offering (IPO) in the US at a valuation of around $4bn.
Secondly, the multi-asset manager looks for exposure via Western companies, which serve the Chinese market.
“That used to be a very simple thing to do,” he explained, “because you just basically bought a big global company that sold to China, whether it was KFC [Kentucky Fried Chicken], Levi Strauss, Coca-Cola or whatever.”
However, it’s not just about selling products or services into China, said Coombs, it’s also important that Western companies understand the market and adapt their businesses.
“There is a huge number of examples where it hasn’t gone so well,” said the manager. “If you want an old one that would be Marks & Spencer opening a shop in Hong Kong, and selling size 14 or 16 dresses: clearly, that doesn’t really fit with the local [market].”
There are more recent examples, though, with Coombs highlighting a meeting with Colgate-Palmolive, which had been struggling to sell toothpaste to Chinese consumers in the face of strong competition.
Yet, rather than adapt and offer flavours of toothpaste that Chinese consumers would like, the firm instead opted to lower prices while promoting products that had been successful in markets other than China.
“What was the Colgate response? Change the price. ‘We are going to force our global marketing and sales strategy on to our Chinese business,’” he said. “We came out of that meeting and sold the stock.
“We came back and sold a lot of our consumer staples after the Colgate meeting because the read-across is significant.”
Currently, there are many large global companies trading at high valuations based on their emerging market and Chinese exposure, said Coombs. However, many of those might be overpriced because they lack the on-the-ground expertise to adapt when consumer trends shift.
“That’s why it’s still important to meet companies as part of your risk analysis. Businesses are run by people and you have to understand how to execute,” explained the Rathbones manager.
“You need to have more exposure to China to grow our client assets over the next 10 years when returns are probably going to be lower than the index levels,” Coombs concluded. “We can’t just stick 5 per cent of it into an Asia ex Japan fund and expect to get the best returns.”
The Rathbone Strategic Growth Portfolio – which is overseen by Coombs alongside assistant manager Will McIntosh-Whyte – is a multi-asset strategy targeting long-term total returns with lower volatility than equity markets.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
It has made a total return of 116.27 per cent over the past 10 years, while it average IA Volatility Managed peer is up 105.64 per cent. The benchmark – the UK CPI (consumer prices index) plus 5 per cent – has made a return of 102.05 per cent over the same period.
The fund has an ongoing charges figure (OCF) of 0.64 per cent.