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Investing in China Opportunities for Global Investors

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Investing in China Opportunities for Global Investors Investing in China Opportunities for global investors 03 March 2021 Chief Investment Office GWM Investment research This report has been prepared by UBS Switzerland AG, UBS AG Hong Kong Branch, UBS AG London Branch, UBS AG Singapore Branch and UBS Financial Services Inc. (UBS FS). Please see important disclaimers and disclosures that begin on page 32. Contents 05 09 15 Why China: Too big and Chinese equities: Multifaceted Chinese bonds: A booming distinct to ignore and rapidly evolving onshore market 20 25 28 Global portfolio considerations: The renminbi: It’s a Multiple risks of China is an attractive diversifier marathon, not a sprint varying magnitude 31 Final thoughts This version reflects updates and corrections on pages 9 and 17. Investing in China Authors Editor Brennan Azevedo Abe De Ramos Learn more at Michael Gourd www.ubs.com/cio Laura Kane Design Lucy Qiu John Choi Lead authors Xingchen Yu Mark Haefele Michael Bolliger Cover picture Min Lan Tan Kiran Ganesh Shutterstock (Pudong, Shanghai, China) Solita Marcelli Barbara Grünewald Alejo Czerwonko Yifan Hu Publishing date Jason Draho Markus Irngartinger 03 March 2021 Adrian Zuercher Tilmann Kolb Eva Lee Language Teck Leng Tan English Chun-Lai Wu Crystal Zhao Contact [email protected] 2 Investing in China – March 2021 Investing in China Over the past 20 years, China’s economy has grown fivefold to become the second largest in the world. For years, China’s financial markets lagged the country's eco- nomic ascendency, but they are now rapidly making up ground. As a result, over the past five years, global investors have started to diversify into Chinese financial as- sets, yet many are still significantly underallocated relative to China’s weight in glob- al equity and fixed income benchmarks. One reason for this behavior is that global investors often lack sufficient understand- ing of the investment opportunities in China. This report aims to help them over- come their hesitancy by demystifying investing in China. We begin by reviewing the equity and fixed income opportunity sets, including their size, characteristics, and market access. We then detail how best to incorporate these asset classes, including China’s currency, the renminbi, into global portfolios. Finally, we consider the macro, regulatory, and geopolitical risks to investing in China. In today’s economic environment, understanding the opportunities in China and con- sidering portfolio allocations there is key. Some of the most compelling growth oppor- tunities in the world are originating in Asia, with China at its core, and they appear very promising against a backdrop of low global growth. And as China and the US, along with other Western countries, pursue divergent economic, technological, and political models, exposure to China can improve long-term portfolio diversification. Mark Haefele Min Lan Tan Chief Investment Officer Head Chief Investment Office APAC UBS Global Wealth Managment UBS Global Wealth Managment Investing in China – March 2021 3 Investing in China Canton Tower Guangdong, Guangzhou, China Why China: Too big and distinct to ignore Burgeoning secular growth Competing great power models opportunities China’s economic and social transformation over the past two billion in 2000 to USD 15.8 trillion as of June 2020, with the vast decades has been nothing short of extraordinary. Given the blis- majority of these bonds issued in local currency. The renminbi tering pace of change, many investors’ view of the country is like- has evolved from being a globally irrelevant currency to the ly years out of date. China now accounts for about 20% of the eighth most-traded currency in the world in 2019, and is gaining world's total economic output and 30% of annual global GDP a spot in central banks’ international reserve allocations. growth, and is now larger than the US economy measured in purchasing power parity (Fig. 1). The rise in living standards has Most of these economic, social, and financial market changes ap- kept pace with this expansion: The percentage of the population pear poised to accelerate as a result of the pandemic. China and living on less than USD 5.5 a day has plummeted from over 80% other north Asian countries have managed to control the disease in 2000 to less than 24% today, while the middle class now relatively successfully, allowing economic growth to normalize makes up about 50% of the population. more rapidly, and leaving them well positioned to deliver sustain- able growth in the future. This is one reason we expect returns This transformation has been accompanied by an increase in the on Chinese equities and fixed income assets to be solidly above size and liquidity of China’s asset markets. Its equity market capi- their developed market counterparts in the coming years. talization is 25 times larger than it was in 2002 and now makes up close to 11% of the global total (Fig. 2). The market for trad- The prospect of relatively high returns may already be enough to able debt securities has also grown exponentially, from USD 200 justify larger allocations to Chinese assets, but what makes them more compelling is the size of the growth opportunities as the economy evolves. Not to be ignored is how China's strategic Figure 1 competition with the US offers a way to diversify portfolios from Rising economic inuence being implicitly reliant on a single economic model. Chinese GDP as % of world total in PPP terms, with forecasts 25 Figure 2 20 China's growing opportunity set Market cap (equities) and total notional outstanding (bonds), in USD billions 15 50,000 10 45,000 3x 4x 40,000 5 35,000 30,000 0 25,000 2000 2005 2010 2015 20202025 20,000 China 15,000 53x United States 10,000 25x Note: Countries report GDP data in their own currency. To compare the data, each country’s 5,000 statistics must be converted into a common currency. One way to do so is to use market ex- change rates. Another commonly used approach is to employ purchasing power parity (PPP) 0 exchange rates—the rate at which the currency of one country would have to be converted China US China US into that of another country to buy the same amount of goods and services in each country. Bond market Equity market While the US economy measures larger than China when using market exchange rates, the 2002 2020 opposite is true when employing PPP ones. Source: IMF World Economic Outlook, UBS, as of October 2020 Source: Bloomberg, BIS, UBS, as of February 2021 Investing in China – March 2021 5 Burgeoning secular growth opportunities Figure 3 China has long shed its reputation as just a center of cheap US and China led global IPOs in 2020 manufacturing. The country is striving to innovate and achieve technological self-sufficiency. Its trade war with the US has Amount in USD billions (shaded bars, lhs); number of IPOs (red dots, rhs) only intensified this ambition, and we expect the Chinese econ- 160 600 omy to become more digital, smarter, and greener over time. 140 500 120 The government's latest five-year plan makes clear its goal of 400 100 reducing China's dependence on foreign technology. R&D spending is growing twice as fast as that of the US, and the 80 300 60 country has the world’s second-largest number of “uni- 200 corns”—privately owned startups with valuations in excess of 40 100 USD 1 billion. This is evident in IPO activity in 2020, as China 20 and the US towered over other regions in terms of number 0 0 and dollar value of new equity offer ings (Fig. 3). US China Europe Asia ex China Rest of World Operating companies China ADRs Furthermore, China is now home to the largest stock of super- US SPACs Number of IPOs computers and industrial robots. Enabling technologies like 5G, Source: Bloomberg, UBS, as of 31 December 2020 artificial intelligence, cloud computing, and big data are pow- ering smarter infrastructure across China, as described in our Longer Term Investments (LTI) report "Enabling technologies." view on China’s leading internet platforms, select banks, and global fintech leaders, as detailed in our "E-commece" and The push toward tech-enabled infrastructure is closely linked "Fintech" LTI reports. to China’s ambitions to achieve carbon neutrality by 2060, by improving energy efficiency and supporting the transition to Competing great power models renewable energy and vehicle electrification. The abundance The current world order emerged right after World War II, with of greenfield projects as part of ongoing industrialization puts the creation of the Bretton Woods monetary system and US-cen- China in a unique position to leapfrog in the energy transition. tered multilateral institutions, including the United Nations, the We forecast that China’s green ambitions will drive a twofold World Bank, and the International Monetary Fund. For decades rise in solar installments, 40% growth in wind installments, since, the US remained the undisputed global leader. But the data and a fivefold increase in electric vehicle (EV) production by on the next page illustrates that the global order is changing, and 2025. China is a leader in EV battery cell technology, and lim- the US now has to share some of the spotlight with China. ited supplies could open a path for it to penetrate foreign markets in the future, as outlined in our “Smart mobility" and Thus, it’s no wonder that the US and China have been clash- "Greentech goes global” LTI reports. ing more often in a growing set of realms in recent years. As Graham Allison describes in his book Destined for War: Can Finally, China is leading in the digital disruption of the retail America and China Escape Thucydides’s Trap?, situations in and financial industries.
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