China is too big and too distinct to ignore

China’s annual National People’s Congress got underway at the end of last week with Premier Li Keqiang highlighting the economy’s recovery from an “extraordinary” year dominated by the coronavirus pandemic and a global economic recession. China was the only major economy to record positive growth in 2020.

But the country’s longer-term track record is more impressive. Over the past 20 years, China’s economy has grown fivefold, and it now accounts for approximately 20% of total global economic output and 30% of annual global GDP growth. Meanwhile, its equity market capitalization has increased by 25 times and now accounts for close to 11% of the world’s total.

Yet many global investors remain significantly under-allocated to China relative to its weight in global benchmarks. In our latest report "Investing in China," we seek to demystify the nation’s financial markets and highlight the opportunities they present for investors.

1. China has become too big and distinct for global investors to ignore. China is targeting growth of “over 6%” this year, but we think the economy will likely grow by more than 8%. The nation is also becoming a leader in technology and innovation. Its R&D spending is growing twice as fast as the US's, and it’s home to the largest stock of supercomputers and industrial robots. China has set the goal of achieving carbon neutrality by 2060, enabled by smarter infrastructure and leadership in battery cell technology for electric vehicles. China is also leading in the digital disruption of the retail and financial industries, accounting for 57% of the global e-commerce market.

2. Financial markets are maturing, making it easier to access investment opportunities. In 2018 China allowed foreign credit rating agencies including S&P, Fitch, and Moody’s to set up China subsidiaries to rate Chinese bonds. This enabled global investors to assess issuer risk in a familiar manner. China has also made it easier in recent years for global investors to gain access to the full set of Chinese equities. Foreign investors can gain exposure to offshore equities and ADRs through either individual stock purchases or a wide range of funds. With the gradual increase of onshore stocks' representation in global benchmarks, it is now easier for foreigners to invest.

3. Investing in China offers a diversification benefit for global investors. China’s economic and interest rate cycles often diverge from major global markets, thanks to its domestically oriented economy and independent monetary policy, which is uncoordinated with developed market central banks. For example, in 2018 the Federal Reserve hiked its policy rate by 100 basis points as the US economy was growing above trend, while the People’s Bank of China cut the reserve requirement ratio by 250bps as the Chinese economy slowed. As a result, bond yields rose in the US and fell in China. China’s equity markets also provide diversification advantages. The MSCI China A Onshore Index has had a historical correlation of 0.5 with the MSCI All Country World Index (ACWI), whereas the correlation is 0.84 for MSCI Emerging Markets and 0.97 for MSCI USA Index, based on five-year weekly data.

So, incorporating Chinese assets into a global portfolio can provide meaningful diversification benefits. We also think that exposure to Chinese markets can boost returns. For example, some sectors exposed to China’s digital economy offer a 20–40% CAGR over the medium term, in our view.

For more on investing in China, and emerging markets more broadly, click here.

Mark Haefele

UBS AG