According to Laura Luo, head of Hong Kong China equities, Chinese companies justify a higher valuation multiple than what they are currently trading at and the fund house sees “plenty of scope” for this to happen, as both price-to-book and forward price/earnings multiples are well below the historical mean.
“We think investors could see the market climb higher after Chinese New Year as market participants update their investment models to reflect changing assumptions,” Luo said.
“We think two factors will lead to a re-rating of China’s equity market. The first is the application of a lower risk-free rate by investment analysts, reflecting interest-rate deregulation and rate cuts. The second is a reduced equity risk premium due to deleveraging and progress on reforms.”
Luo also expects improvement in companies’ margins on the back of cheaper oil and raw material prices, reduced financing costs due to the recent rate cut and improving liquidity.
“We see potential for the China equity market to climb higher in this scenario, especially if domestic investors continue to increase their allocation and are joined by overseas institutional investors, who appear to be underweight in China currently.”
Luo finds her best investment ideas coming from companies that are the beneficiaries of China’s ongoing structural reforms such as non-bank financial companies and state-owned enterprises.
Her second investment theme involves companies that are active in the domestic economy and potentially well-positioned to capture a growing share of China's domestic spending.
Healthcare, tourism, education and other service sectors fall into this category.
She also likes companies that are able to offer productivity gains as part of their business proposition.
“These are typically involved in the information technology and industrial automation fields, and offer excellent potential for long-term growth.”