Consumer confidence and sensible monetary policy will continue to boost growth in China as the country emerges as a viable contender to the US, according to Somerset’s Min Chen.
Chen (pictured), the former head of China at RWC Partners, joined Somerset Capital Management in November 2020 as head of China and lead manager of the Somerset China strategy. He will head up the launch of a China fund that will be available to UK investors later this year. 
Chen is constructive on the Chinese economy and stock market as a whole, citing the consumption-driven recovery, sensible monetary policy and abundance of quality-growth companies as reasons to be bullish.
He argued that from a long-term perspective the Chinese stock market has the potential to hold great value for investors. “Long-term valuation measures, such as the Buffet indicator, show China at about 80 per cent,” he said. “Other metrics too show that China is attractively valued.”
China is still relatively under-represented in the MSCI AC World index with a weighting of just 5.5 per cent, despite accounting for 16 per cent of global GDP.
Indeed, the Chinese economy has recovered well from the early stages of the pandemic and grew by 6.1 per cent in the fourth quarter of 2020.
Annual % change in China’s GDP
Source: FT
But China’s weighting in global indices will likely change when the country is eventually recategorised as a developed market, leaving the emerging markets behind.
In terms of the investment approach at Somerset Capital, Chen outlined the firm’s long-term standardised process, which keenly taps into the Chinese market.
“We’re active stock pickers and are willing to go down the market-cap chain to find the gems which are not as well covered as their mega-cap counterparts,” he said.
A common criticism of broad Chinese exposure is the concentrated nature of Chinese indices, where companies like Tencent and Alibaba dominate.
“A lot of China funds look quite similar with a huge amount in high-quality companies with a high correlation to each other,” Chen added
Overall, China has over 5,000 listed companies, thus allowing for clear diversification opportunities within the whole universe.
“That leaves a lot of room for active stock pickers like us,” he said. “It’s a market that can harbour a lot of different strategies.”
The consumption-driven recovery is something that Chen is increasingly optimistic about, in particular the idea of discretionary consumption, which has often been touted as an important long-term trend.
As China’s rising middle income class (which is expected to be over one billion in the coming years) meets strong household balance sheets, this will create a unique opportunity.
“The middle class has very individualised demands,” said Chen. “Those demands will help create a new product and new brands, avoiding the crowded, more well-known consumer names.”
However, there is a case to be made that Chinese consumers may still be hesitant to spend when a global pandemic is still a present threat.
“Consumer confidence is coming back. It’s the bright spot in China’s economy,” he said.
“Consumption will take the leadership in the economic recovery and that’s what we believe is unfolding. Sales are seeing good momentum and we remain confident about the economic recovery.”
He added that consumers have been reassured by the relatively sensible monetary policy central banks have had in place since the pandemic began.
In other developed markets, huge stimulus packages in response to Covid-19 have successfully prevented economic collapse, but rising debt and easy money can be quite worrying for the average consumer.
Inflation is one such worry that has gathered momentum in UK and US economic circles over the last year.
Large-scale quantitative easing and pent-up consumer demand are expected to converge at some point over the next few months, which could see a short-term surge in inflation.
With increased consumer spending and growth expected to be above 6 per cent for 2021, inflation in China is also a mid-term risk.
“Inflation will return in some capacity,” said Chen. “It’s a near-term risk. Having said that, the policymakers have been quite restrained in the monetary policy and interest rates are still reasonably high.”
With the current interest rate at 3.85 per cent, it certainly gives the Chinese central bank some room to manoeuvre. This, in contrast to the Bank of England, that has little room to breathe.
The base rate is currently at 0.1 per cent and governor of the BoE, Andrew Bailey has even hinted that negative rates are not off-the-table.
“Investing in China is important, “he said. “As an asset class, China is too big a market to ignore, with a superior amount of quality companies.”
With a return-on-equity of over 8 per cent and three-year earnings capability of over 12 per cent, China has more quality companies than the US, the manager noted.
“The clear improvement in corporate governance will decrease the risk premium and that will further help long-term valuations in the market,” he added.
As an increasing number of UK income investors look east, China has strong credentials to attract disenfranchised dividend-seekers.
“These are decent growth companies which are willing to pay out their dividends as part of good governance practises,” said Chen. “Furthermore, dividend payout ratios have risen over the years which is reassuring trend.”
Currently domiciled in The Cayman Islands, the Somerset China strategy will launch a fund for UK investors later this year.