Should you play old or new China?

With the Chinese economy set to undergo a long-term shift from an investment-driven economy to one led by consumer growth, investors are split on whether to focus on new industries such as information tehcnology and consumer-facing stocks or stick with the more traditional and out-of-favour sectors such as industrials. 

The Chinese government finally began to tackle the widely held view that the economy needs to steer away from massive investment projects in the industrials sector to focus more on generating consumer-led growth back in November 2013 through a number of policies featured as part of the economic blueprint unveiled at the Third Plenum.

Some investors are now looking to China’s newer consumer-focused sectors on the back of this emerging theme but others argue that the more traditional industries such as infrastructure can make for a cheaper way to tap into consumer growth.

The Scottish Mortgage Investment Trust at Baillie Gifford believes that China can “become one of the dominant global economic powers”, placing a number of internet and consumer-facing stocks at the centre of this theme for their growth potential.

Deputy manager Tom Slater focuses on internet service portal Tencent and web services and social network company Baidu, as well as one of the trust’s unlisted holdings and China’s answer to eBay, Alibaba.

He says: “The progress we see from the companies we invest in makes us most excited. Baidu and Tencent have both grown their revenues at over 60 per cent per annum for the past five years. These are both now large businesses but they still seem to us to be at a very early stage of their development.

“However perhaps most striking in terms of sheer scale is the progress made by one of our unlisted holdings, Alibaba. The value of goods from Alibaba’s platform last year was more than twice the size of eBay and Amazon put together.”

Chelsea Financial Services managing director Darius McDermott also favours sectors in what he describes as the “new China”, which should benefit from an increase in consumer demand.

The £11m Fidelity China Consumer fund, manager by Raymond Ma, is highlighted by McDermott for its tilt towards these areas of the Chinese market.

“Whereas in the past, materials, energy and industrials benefited from China’s rapid expansion, he is looking at ‘new China’ sectors which should benefit from the changes ahead, for example: consumer discretionary, IT, insurance and healthcare,” McDermott says.

“These new sectors have substantial room to grow as the economy develops and my personal view is that, while luxury brands have been the story for some time, I think the next real opportunity in China will come from a more moderate level, as the working and middle classes look to purchase affordable products and services.”

However Hermes Asia ex Japan Equity fund manager Jonathan Pines points out that certain areas within infrastructure, such Chinese ports, will also receive a knock-on benefit from consumer growth.

“If you have got a more consumer-led economy it means that your people are going to be consuming goods from other places in the world. So China is not just going to export, the country will be earning and importing as well and if you are in ports then you benefit both ways from this,” he says.

“With all the problems that people are saying China is having this year, the volumes going through the ports we have in our portfolio are up about 10 per cent.”

Pines also adds that with market attention focused on the consumer theme and more defensive areas of the market, these more traditional cyclical industries have become unloved and therefore currently look cheap.

“These are very high quality companies but the problem that investors have with them is that they are cyclical and their earnings are not predictable on a quarter by quarter basis so they have are cheap,” he adds.

“However we think over time there is a very good chance that these companies will grow their earnings.”