China: An Inefficient Frontier For Active Managers

Includes: FXI, FXP, GXC, PGJ
by: Invesco US


China’s economy remains one of the fastest growing, despite recent indicators signaling a deceleration that is raising investor caution.

We believe the downtrend gives credence to the government’s commitment to comprehensive economic reform and social reform.

The rise of private enterprise and the state-owned enterprise reform to curb excess capacity are among the comprehensive reforms that will drive growth.

By Joseph Tang of Invesco

Despite its recent slowdown, China remains one of the world's fastest-growing economies, and valuations have become very compelling. In 2014, the MSCI China Index is trading at a price-to-earnings ratio of 8.8x versus its 20-year historical average of 12.4x. While the index may be a proxy for China's market capitalization, we don't believe it reflects either growth drivers or investment opportunities, which allows active managers to take advantage of the index's inefficiency.

Reforms revisited

While investors have become cautious due to recent economic data - sluggish 7.4% first-quarter gross domestic product (GDP) growth was the slowest in 18 months - we believe China offers a compelling environment for active managers. Although down-trending indicators may create short-term headwinds for Chinese equities, in our view the data give credence to the government's proactive commitment to comprehensive reforms and acceptance of a milder growth target in exchange.

And reform appears to be well underway. For example, private enterprise now accounts for 74% of China's sales revenue and 80% of urban employment. The rising importance of private enterprise results from China's reform to migrate to a more market-driven economy, and we believe it will continue to be a growth driver. In addition, the government's state-owned enterprise (SOE) reform, a key initiative to curb excess capacity, will improve the efficiency of SOEs and, in our view, shareholder value.

The scope of these reforms is arguably the most comprehensive in China's history. When fully implemented, they will range from demographics with abolition of the one-child policy, to financial with interest rate liberalization, to environmental with emission controls. We believe the economy and Chinese corporations will benefit greatly over the medium and long term.

Bullish consumption story

China continues to have a compelling consumption story few markets can touch:

  • Year-over-year double-digit retail sales growth has been robust and consistent.
  • Although investors have been concerned that China's anti-corruption campaign could dampen retail sales, data show that growth is holding up well, with slowdowns evident only in the gift-oriented tobacco and liquor sectors.
  • The service industry's share of GDP has finally surpassed that of the industrial sector for the first time in China's economic history.

The bottom line in China? We see ample bottom-up opportunities for active managers.


  • Bank of America Merrill Lynch, as of April 24, 2014
  • Bloomberg L.P., as of April 16, 2014
  • CEIC and CLSA, as of March 18, 2014

Important information

The MSCI China Index is an unmanaged index considered representative of Chinese stocks. An investment cannot be made directly in an index.

Price-to-earnings is a valuation ratio of a company's current share price compared to its per-share earnings.

About risk

China remains a totalitarian country with the following risks: nationalization, expropriation, or confiscation of property, difficulty in obtaining and/or enforcing judgments, alteration or discontinuation of economic reforms, military conflicts, and China's dependency on the economies of other Asian countries, many of which are developing countries.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.


All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is a U.S. distributor for retail mutual funds, exchange-traded funds, institutional money market funds and unit investment trusts.

Invesco unit investment trusts are distributed by the sponsor, Invesco Capital Markets, Inc. and broker dealers including Invesco Distributors, Inc. These Invesco entities are indirect, wholly owned subsidiaries of Invesco Ltd.

©2014 Invesco Ltd. All rights reserved.

Additional disclosure: The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.