The slowdown in the Chinese economy and aggressive regulatory measures by President Xi Jinping rocked investors and caused Chinese stocks to fall. However Justin Leverenz, manager of the 51 billion dollars
Invesco’s Developing Markets
(ticker: ODMAX), is bullish on China and Asia. Although he began to reduce his stake in
Alibaba Holding Group
(BABA) due to competition concerns before Beijing’s latest regulations threaten China’s biggest internet companies, he predicts an upcoming Chinese equity bull market, propelled by cash-rich domestic buyers. He also expects a rally in commodity prices that could reverse the decade-long rout in emerging markets.
The Leverenz fund returned 14% last year, lagging behind its peers. But its record is impressive: the fund has outperformed 94% of its peers over the past 15 years, with an average return of 7.6% per year, according to Morningstar.
He recently chatted with Barron why he loves Chinese stocks, what tech stars are emerging beyond China, and what commodity company investors lack. A modified version of the conversation follows.
Barron: Chinese stocks took a hit as Beijing stepped up regulations, placing restrictions on listed companies overseas and renewing its focus on social good rather than profitability. What does this mean for investors?
Justin Leverenz: It’s a polarized environment, with Chinese apologists and tourists – those who don’t have to get involved and call [China] not investable. I am sitting in between. While a large part of [the regulation] has come dizzyingly, China is going to have an uber bull market in the next five to 10 years. The investment will be national in nature.
What will push the Chinese into the market?
The least talked about part of the regulation is the emphasis on not increasing leverage in the system and reconfiguring growth. Part of this is increasing restrictions on real estate speculation. Chinese households have the second largest balance sheet in the world. This will shift into equities, as it did in the United States in the 1980s and 1990s, and result in a significant bull market. A multi-year transformation of household asset allocation in China will drive prices. Why shouldn’t we be part of this explosive opportunity?
It is abnormal for a country as large as China to have its most important companies inaccessible to domestic savers [because they are listed on non-Chinese exchanges]. The effort to create a domestic market, albeit offshore in Hong Kong, and therefore more easily control capital flows, is an important part of the math.
Why is it so important for China to develop its capital markets?
China’s biggest goal is to become independent in an increasingly hostile world. China must face up to its weaknesses: energy, semiconductors and [the dominance of] the dollar.
China wants to create a deep and liquid capital market. It is the largest trading nation, but almost all trading is done in dollars and euros, and it wants to transfer some of it to the renminbi. But people, governments and businesses do not have the capacity to hold RMB in cash. [due to capital controls]. Hong-Kong market is designed to allow the renminbi to be a more important international currency.
But isn’t China hurting itself by cracking down on Hong Kong’s independence?
I don’t think China has an interest in harming Hong Kong’s development as a domestic offshore capital market, as this is critical to China’s geopolitical situation.
The United States rightly believes that there are certain norms of behavior, whether related to Hong Kong, human rights abuses in Xinjiang or Taiwan, while China views these issues as issues of national sovereignty. This [says the U.S.] has its own social and civil rights issues, and that we should live in a pluralistic world and not encroach on sovereignty.
What are some of the underestimated effects of Beijing’s regulatory campaign?
Even Chinese apologists have failed to recognize that this regulation is good for cash flow. This will allow [previously] destructive competition to become much healthier. While growth will be lower, it will be much more focused on realistic profitability. There will be a trade-off in valuations, but the cash flow will be considerably higher.
Your fund has a lower weighting in Chinese and Internet companies than its peers, but
[700.HongKong] is a leading position. Why?
Tencent’s core business – its gaming platform – is reasonably defensible, even as the focus is increasingly on using minors’ time. [China’s new policy limits online gaming to three hours a week for all children.] Tencent has fingers in all the major game companies around the world as an investor and as a publisher who can import these games into China.
How is the rest of the business doing?
Tencent’s other main levers [advertising and investments in other companies] are energized. The Chinese economy will slow down. Moreover, this aggressive, unruly and destructive competition is going to be at a distance. It means advertising [becomes less crucial] and will experience cyclical stress.
The other part, subject to structural stresses, is Tencent’s listed investments in large companies such as
[SE]. Tencent is one of the most successful venture capitalists on the planet, but this game will be tough over the next couple of years. Its capabilities in this new environment, which is anti-platform business, are probably circumscribed.
What should investors look for outside of tech stocks?
The regulatory assault has another deeper goal: to correct inequalities in China. From 1980 to the global financial crisis, there was enormous social mobility, until the last 10 years. Another way to think of the Xi administration is that it looks like the FDR administration. It is geared towards the rebirth of equal opportunities in China, whether for political or populist purposes or to guide development. You are going to see a huge redistribution in society – and it will benefit the bottom of consumption, like fast food restaurants, travel and hotels.
Who are the beneficiaries?
Yum China Holdings
[YUMC], which owns quick service restaurants, are the largest players in fragmented industries with huge organic growth.
Huazhu is incredibly tech savvy, which cuts costs and improves customer satisfaction. It is largely a network of franchises. It has 10,000 hotels and may reach 15,000 to 17,000 hotels in the next five years. The company also has a huge membership system and can fill the majority of nights at high occupancy levels in a non-Covid world.
Will the Chinese economy continue to slow?
People are going to panic about the next few quarters of growth. But over the next five years, China will generate 4-5% annual growth. This is the great story of the world’s growth.
Emerging markets, excluding China, have lagged the S&P 500 by 10 percentage points over the past decade. Why shouldn’t investors give up?
Emerging markets outside of China have been in deep trouble because of commodity prices, which will be in tears. It will uplift much of the non-Chinese world, including Russia, the Gulf States, Latin America, Indonesia, and South Africa.
One of the biggest themes of our life is linked to climate change and the energy transition. It is the opposite of the last three decades, which were entirely devoted to technology, [which is] deflationary and requires little work. This transition will be perhaps the most capital-intensive investment humanity has ever made.
We are going to be in a massive commodity cycle for a long time, not just because of the resource intensity of [renewable] projects, but because the supply was restricted because the raw material companies were restricted [by shareholder preferences for dividends and cash flows over mergers and investment.]
You own a Brazilian iron ore miner
[VALE], which fell 25% last month as iron ore prices plummeted. What are investors missing?
For the past 10 years, Vale has focused on expansion and market share rather than profit making, but [recently] he has made it known that his focus is on generating cash flow, not market share. You will see long-term iron ore prices drop from $ 60 to $ 70 per tonne to $ 100 to $ 150. Vale has reduced its debt, which means its double-digit free cash returns will flow to shareholders. It is an extraordinary investment.
What else did investors miss as they focused on China?
Scholarships that were out of date now [offer] a different set of investment opportunities that will be attractive. In Brazil, the main companies include
[MELI], and asset manager
[XP]. Nubank would go public in the fourth quarter. In South Korea, new companies are listed, such as the games company
[259960.Korea], e-commerce company
[CPNG], and internet giant
[35720.Korea]. In India you have a food delivery business
[543320.India] and at least a dozen unicorns are expected to be released to the public over the next 12 months. In Southeast Asia, there is Sea, but also GoTo and Grab, made public via a SPAC [special purpose acquisition company].
Write to Reshma Kapadia at [email protected]