Originally published on 28 May 2019
Oscar Pulido: In 1987, China's gross domestic product, or GDP, was just shy of $273 billion. Sounds like a lot, right? Fast forward 30 years to 2017. GDP was over $12.2 trillion. That's over a 4,000 percent increase. In the same time frame, the U.S. experienced about a 300 percent increase.
China has had huge economic success in the last 30 years. While it was once considered a mainly poor and rural country, it's become a global manufacturing power, and a quickly growing middle income economy. But until now, investors haven't been able to take part in its success. Chinese authorities have kept financial markets closed and prevented them from being integrated with the rest of the world. Now, this is starting to change. The Chinese market is opening gradually, creating more and more opportunities for investors to take part.
On this episode of The BID, we'll speak to Jeff Shen, Co-Head of BlackRock's Systematic Active Equities Group, who believes the market opportunity in China is too big to ignore. I'm your host, Oscar Pulido. We hope you enjoy.
Jeff, thank you so much for joining us today on The BID.
Jeff Shen: Thanks very much, it's great to be here.
Oscar Pulido: And I should say welcome back, because this is now your second time on the podcast, so I think you know how this works.
Jeff Shen: I hope it's a good sign.
Oscar Pulido: Let's talk about China's growth. It's actually really impressive when you think about what they've been able to accomplish over the last 30 years. What's been the catalyst of that?
Jeff Shen: I think number one is China really started to reform starting in 1979. And whenever we think about China, I always tell people that there are three things that are actually most important. It is government, government, and also government. That certainly has been a major catalyst for the country to move from essentially a country that was quite a bit below poverty, think about 90 percent of the population lived below poverty back in 1979. Earning less than $1.19 a day. Fast forward to 2019, there is only less than one percent in this kind of extreme poverty. So I think the policy has certainly been the first most important driver. I think the second one is China joined the WTO in 2001, and that certainly allows China to open up to the rest of the world. And I think it's certainly gone from a country in the 60s and 70s that was actually quite isolated to the rest of the world, to essentially having China come on to the world stage, whether it's trade, whether it's investment. That desire to interact with the rest of the world certainly allows a country to progress quite well since joining the WTO. And so these are the two things that I think we've certainly seen this extraordinary economic growth that we haven't really seen in any other countries or at this type of scale in the human history. So it certainly has been pretty phenomenal.
Oscar Pulido: And you mentioned government. So back in 2015, China's president Xi Jinping unveiled the Made in China 2025 plan. What exactly are the details of that plan and is this also one of the reasons why we continue to see this extraordinary growth?
Jeff Shen: Made in 2025 is certainly a way to think about to the next phase of economic growth for China. And I think, if you will, this mindset in China that what got you here won't get you there. So for the next every five or ten years, you've got to do something that is fundamentally different. And Made in China 2025 is certainly emphasized from a growth perspective the country's got to go from the quantity of the growth into the quality of the growth. And to go for quality, essentially you need to have a lot of technology to enable you to swim up on the value added curve and there is quite a bit of discussion around electric cars, AI, robotics, big data. So there is certainly quite a bit of emphasis on using technology to drive the economic growth going forward in this. And I think the one last thing I want to say that is I don't want people to get the impression that it's a new thing. In the sense that China is actually pretty regimented about coming up with these five five-year plan, 10-year plan, 20-year plan. And the technology certainly has been in a bit of DNA in the country, certainly produces one of the largest science and engineering graduates in the world. I think it's important to think how this is actually not that much different from what the country has been doing for the last 30, 40 years.
Oscar Pulido: Is China unique in its ability to think more strategically about its economic plan? It feels like sometimes maybe we just hear a lot of the short-term news about quarterly growth in an economy, maybe a new piece of legislation. But what you're describing suggests that China thinks with a much longer time horizon than maybe other countries, other governments.
Jeff Shen: Yeah. I do think that this is maybe because of the civilization has been around for a long time, there is a certainly a long horizon planning, long horizon thinking, which I think sometimes is good, sometimes it's bad. But I think it certainly helps for a country of 1.5 billion people to think in a longer horizon, because otherwise, things tend to go much slower. In 2015, we talked about Made in China 2025; that was also the time the government decided on artificial intelligence alone, there is going to be hundreds of billions of dollars that's going to be spent on these types of initiatives, over the next five to 10 years. So this certainly longer horizon allows the government to be much more decisive in driving some of these key initiatives.
Oscar Pulido: And you mentioned artificial intelligence, and I think you mentioned robotics. China is becoming a bigger player in technology, so as they transition from being more about quantity of production to quality, it's certainly a benefit for China, but is that a benefit to the rest of the world, or is it a threat to the rest of the world?
Jeff Shen: I think there are two elements here. One is I do think that China is about 1/6, 1/7 of the world's population, so from that perspective, if we can use technology, whether it's AI or big data or robotics, to make life for 1.4 billion people better, I think that in itself is certainly a good thing for the human race. And I think as to the impact to the rest of the world, this is not necessarily a zero sum game, in the sense that the technology discovery will certainly benefit countries, not in a singular sense, but really in a plural sense across the globe. And I think that certainly has been the case in scientific community, if there is a major breakthrough discovery, that type of discovery certainly tends to be beneficial to the overall community. At the same time, I do think that this is not going to the park to have a picnic either. I do think there is some element of competitiveness in there, in the sense that it does drive a bit of a competitive edge for different companies or governments. You can also think a little bit along the lines of military. So I think that part is certainly I think also part of the reason why that's introduced in some geopolitical tension, because for the rest of the world, China does present different economic growth model that is quite different from how we traditionally think about capitalism, that it should be. So I think that alternative model as it gets stronger, as it gets infused with more AI and robotics, it does worry the rest of the world a bit.
Oscar Pulido: So you said "geopolitical tensions," and it feels like the headlines that we read about China have those words in them all the time, and we lose sight of the longer-term perspective of what's been going on from a growth perspective. What's your opinion on the trade war, what is its impact on the Chinese economy, and how should we think about it in terms of investing in China?
Jeff Shen: I think the trade war can really be thought about as a bit of a tip of the iceberg. The trade deficit between China and the U.S. has certainly been around and persists. And I think that is an issue that is quite a focal point. At the same time, I think underneath the surface, we can certainly mark 2018 as a year that the U.S./China relationship has gone from historically, certainly has been a model of cooperation to the new phase of a model of competition. And I think given just the sheer size of the Chinese economy, even though on a per capita basis, it's still a below middle income developing country, but given the population size, and also the transformation it's gone through, that certainly has created a bit of a tension. It's actually not only with the U.S. - it's actually also with the rest of the world. Think about state ownership, the political system that is very different from a typical Western growth model. So I think it's not only the economic interest, but also what is the ideal way of growing that is presented to the rest of the world, that is at stake here. So I think we are entering the phase of competition - that being said, that may not always be bad. A bit of a competition can potentially drive a bit of a growth and innovation that we have seen before. So I don't think it's all bad, but I do think, at the same time, that we need to recognize we're going into a new era.
Oscar Pulido: Does China think more about prioritizing growth and less so about managing some of these geopolitical relationships? That is what it sounds like listening to you talk, and that is what it sounds like will be the case at least in the foreseeable future. But at some point, does China start to really think about the importance of maintaining more stability in some of these geopolitical relationships? Or will it always just be about growth?
Jeff Shen: I think the rising tide certainly can lift up a lot of boats from a domestic perspective. I think the growth can certainly lead to domestic stability, which if you think about the growth that's been happening in China over the last 40 years, that certainly allows the Communist Party to be much stronger and also extraordinarily well-liked in the country. So I think domestically growth has actually been a recipe for success. It is the case that the economy is large enough, the global implication is certainly one that is sometimes outside the Communist Party's direct control. If you think about the populism that we see around the developed countries, a lot of the jobs actually have gone away in the developed countries either because of globalization or maybe, actually, importantly, because of technology. But nevertheless, you just need to go to some of the manufacturing centers in some of the developing countries to realize that the China story rising up on the horizon certainly has global implications. And that is something that I think China has to think about it - I think they've been forced to think about it, so this is actually giving us additional context to think about not only just growth in its full form, but also what are the collateral damage, what are the opportunity costs, of that growth? Whether it's the environment, whether it's the global implication, these are the things that are additional problems as China rise up on the stage, that it needs to think about.
Oscar Pulido: There is no question that the economic growth story in China is very impressive, it sounds like government plays a big role in that, it's having effects around the world on other economies. But then let's talk about the investment opportunity, because many times we hear about economies that are doing well, but that doesn't necessarily mean the stock market of that economy is doing well. When you think about the investment opportunity then in China, actually buying companies in China, is there a compelling case there the way you've made a compelling case around the economy?
Jeff Shen: I think the relationship between growth and the investment returns is certainly a complicated one. And especially when it comes to China, I think it is even more complicated. Higher growth doesn't always necessarily mean if you just buy and hold a bunch of companies, you're going to make a lot of money. So I think in China the exciting thing that happened in 2018 certainly has to do with the MSCI inclusion of the Chinese A-shares market into the global equity market. And this is certainly a market that historically, international investors have had very little access to it, most of the holdings have been through the domestic institutions, and importantly, domestic retail investors. So that market essentially has stocks that are traded in Shanghai and Shenzhen, that is opening up to the rest of the world through Stock Connect mostly. And so that is a big deal in my mind that this is a give or take, around $8 trillion in market cap, and that's a big market, that is actually opening up to the rest of the world. There are 2,000 plus stocks listed in there and the market trades $40 to $50 billion a day. There is a large deep market. And I think for investors who want to tap into the growth story of China, I think it certainly presents a pretty rich opportunity set.
Oscar Pulido: Talk a little bit more about when you say the markets are opening up, because I think for many investors, at least the way I think about it is that investing has become very democratized. It's a lot easier to invest in markets around the world. So it sounds like it wasn't easy to invest in China maybe not so long ago, but what does opening up mean practically?
Jeff Shen: Yeah. Before, as international investors, certainly you can invest in Chinese A-share market, stocks listed in Shanghai and Shenzhen. But it was a pretty complicated process to do that. You needed to go through what people typically call a Q fee, quota license to be able to invest in that. And it's a lengthy, a bit cumbersome process to go through that. It took us also a while to get a license to invest in that. We got it about seven years ago from BlackRock as a firm perspective. Sometimes people joke that my second PhD in anthropology always takes a little bit longer to get than the actual license. But I think fast forward to today when we say opening up, is that if an international investor can invest in stocks in Hong Kong, now they can essentially invest in stocks in Chinese domestic A-shares market. So I think it's very exciting for the international investors, the process is getting to be much more robust and open. So you just need to pick the right ones.
Oscar Pulido: If I look at the S&P 500, I look at an index that's very diversified, companies of different sizes, the sector representation is pretty diverse. You have banks, you have tech companies, you have healthcare and the list goes on. If I were to look at the A-shares market in China, what is the composition of that market look like from a sector perspective? And talk a little bit about the corporate governance of the companies in China: Should we have the same level of confidence in corporate governance that we would maybe with a U.S. or European company?
Jeff Shen: Yeah. I think the sectorial composition is also quite diversified. So whether it's MSCI indices of Chinese A-shares market, or locally they also have a CSI 300 Index, when you look at any of these sectorial compositions, they are actually quite similar to the rest of the world. They are quite diversified, it's a large economy that has not only got a state-owned enterprise, but has also got a large representation of the privately owned companies, some are exporters, some are also very much domestic-oriented. And I think the interesting thing of the Chinese A-share market is that we can also gain access to some of these domestic consumption stories that you probably historically haven't really been able to get that exposure to through international equity market. Now the corporate governance element of it, the typical perception is that for emerging market countries, sometimes these corporate governances may be a little bit below the international standard. The Chinese governance structure is actually quite strong. The stock exchange actually requires quite a bit of documentation, compliance and information for any companies to be listed and there is even quite a bit of requirement on the company to make profit for three years before they can even be considered as listed, especially in the main stock exchange, in Shanghai. So, I think the governance and also transparency and information and data, surprisingly, is actually quite abundantly available. The Chinese economy is actually transforming very quickly into a digital economy. So from a data availability, transparency, information, you actually find a lot of that in China that is actually often times to peoples' surprise.
Oscar Pulido: And transparency, the Chinese consumer, or the individual, is a big user of technology and social media, and that leaves a pretty rich digital footprint. In your role, being able to access that data I believe is an important part of how you can analyze the investment opportunity set. How is it that you use that big data to understand where are the better opportunities in China?
Jeff Shen: Absolutely. I think China certainly is a great playing ground for using big data, using artificial intelligence to gain a bit of investment insight. For example, for fundamental information, you can actually use satellite image information to get a sense of the metallic content on the ground, essentially to get a sense whether it's industrial manufacturer or the real estate companies where the metal frames of the buildings are coming up, to essentially get a sense of how industrial production is coming along, or whether there are trucks moving around port, or whether the building site is actually progressing at a normal pace. So you can measure fundamentals using these kinds of alternative data sources like satellite images to give you additional sources of information to validate some of your prediction. Same thing, through social media, you can certainly get a sense of some of the retail flow sentiment, just to get a sense of the 130 million retail investors. Are they loving the stock market? Are they worried? What their mood is. This information certainly historically was never available because people never really blog or Tweet about what they like. But today in aggregated form, you can get a sense of overall market sentiment. So I think we can certainly use some of this new informative alternative data to essentially enrich your understanding of the market, but I think a lot of it is also about asking the right question, making sure that with the new set of data, you can ask some interesting and relevant investment questions, and hopefully we can use new data and tools to gain a bit of an edge.
Oscar Pulido: And what is the data not telling you? I imagine there is still a role for going to China, spending time there, talking to people, that supplements maybe some of the analysis that you mentioned.
Jeff Shen: I think we use a lot of tools, a lot of models, and sometimes people think we are just a bunch of machines. But in reality, humans play an enormously important role in driving an investment result. If you really want to understand what is going on with the government, we talk about how important that is, certainly very important to gain a bit of insight from the policymakers, what's on their mind, clearly you can supplement that with a bit of data science to look at some of the trends people actually use to gain a bit of a sense of what is on the policymaker's mind. But at the same time, I do think that a model at the end of the day, or data, the insights you gain, is essentially a simplification of the world. And the world is pretty complicated. So I think the human's job is certainly around asking interesting questions, but it's also asking, "What is the model missing?" The model has never seen a trade war in its life, but it's certainly going to be important going forward to think about what the new era is going to really mean for investment. So I think this is probably also why we love what we do, because nothing will work forever and you've got to keep innovating.
Oscar Pulido: And with a market as big and complicated as China, I'm sure having all those tools is something that helps a lot. We're going to end with a bit of a rapid-fire round, where I'll ask you a series of more personal questions, I hope you're ready?
Jeff Shen: Absolutely.
Oscar Pulido: I know you live in San Francisco: so I have to ask, electric scooters or electric cars?
Jeff Shen: I think electric scooters with helmet, so take risk but with a bit of risk management.
Oscar Pulido: And this is your mode of transportation to work in the morning or is that just on the weekends?
Jeff Shen: Weekends, I walk to work.
Oscar Pulido: Now I've heard your daughter watches Shark Tank, which shark do you prefer? Mark Cuban or Mr. Wonderful?
Jeff Shen: I think Mr. Wonderful is a little bit scary for my kids, and Barbara Corcoran is actually the family's favorite.
Oscar Pulido: Yeah, Mr. Wonderful is pretty honest, that's for sure. Which idea would you bring to Shark Tank?
Jeff Shen: I think I love artificial intelligence and I also certainly am a big fan of China. So I think maybe a Chinese restaurant with AI-driven robots as servers will be my idea.
Oscar Pulido: Okay. That's interesting. Now you teach a course on international investment at NYU. I happen to know, because I was a student there. And I didn't have time to take your class unfortunately, but what is the one word students would use to describe your teaching style?
Jeff Shen: I think "engaging" may be the word. I do teach an intensive class there that involves 6 hours a day, so that is a lot of coffee and a lot of Q&A, so it's a lot of fun.
Oscar Pulido: And then the last question: Will China's stock market capitalization ever exceed that of the U.S.?
Jeff Shen: I think it's possible, but I think I'm also a big believer of the U.S. market and U.S. system. Again, I think in this case, there is probably a lot of China versus the U.S., but it's China and the U.S. both can be quite good.
Oscar Pulido: Jeff, thank you so much for sharing your insights today and joining us on The BID.
Jeff Shen: Thank you very much, it's great to be here.
This post originally appeared on BlackRock.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.