Investing in China: An informative guide

It was only one year ago when talk of a resurgent Chinese economy attracted the attention of global investors.

Unfortunately, 2024 opened with a bleaker economic outlook than most market participants investing in China likely anticipated, as the Eastern giant is dealing with a slowing economy and weak financial markets.

Economic growth in China

The Chinese economy grew by 5.2% in 2023, with the International Monetary Fund (IMF) pegging 2024 growth at a more moderate 4.6%. Yet, debt, deflation and an aging demographic base point to serious concerns for global investors.

“Despite the stock market’s slipping sentiment and persistent problems with the property market, certain segments of the Chinese economy have also proved their resilience,” JPMorgan Chase analysts wrote in a recent research note. “Nonetheless, a lack of confidence is pervasive and policy will likely need to be more forcefully supportive to stem a deflationary spiral.”

Understanding the Chinese investment climate

Economic forecasts for China in 2024 are somewhat bearish. Some analysts call for economic recovery, and some see continuing stagnation. A healthy dose of politics could potentially muddy the investment waters.

Xi Jinping, president of the People’s Republic of China since 2013, has prioritized a political and social concept of “comprehensive national security” as the country’s top political class objective for 2024. Pushing overt security measures seems to be at odds with China’s recent embrace of quasi-capitalism. With the country’s major industries and financial markets viewed as underwhelming in 2023, Xi may take his foot off the accelerator and focus on economic growth in 2024.

Currently, China’s investment climate is facing an uphill climb, as key issues like tepid economic growth, shaky unemployment (particularly for China’s younger citizens), soft wages among the county’s reeling middle class and an ongoing real estate crisis remain front and center in 2024. Thus, the hope among some regional investors is that Xi will pivot from a “walls up” public policy stance to a more welcoming economic policy that would attract much-needed foreign cash.

“Currently, the Chinese investment outlook is a mix of potential and uncertainty,” said Ronan Ye, founder and managing director of 3ERP, a rapid prototyping services and 3D printing company in China. “China has relaxed some Covid-zero policies, which could lead to a rebound, but geopolitical tensions remain.”

Here’s what Ye said he sees as the biggest Chinese investment impactors for the rest of 2024:

• Government policy: China’s focus on domestic economic stability and its evolving regulatory landscape “will significantly impact investment decisions,” Ye said.
• Global economic trends: China is deeply integrated into the global economy. “Slowdowns in other major markets will affect investments,” he noted.
• Geopolitics: Tensions with the United States and other countries introduce risks and uncertainty.
• Technology and innovation: China’s emphasis on these sectors “has led to booms in specific industries and regulatory scrutiny in some cases,” Ye added.

Investment opportunities in China

Given forecasts for a still-strong 4.6% GDP figure for 2024, the Chinese economy may be jelling just in time for global investors.

“Let’s start with the undeniable draw — the sheer scale and long-term growth trajectory of the Chinese market,” said Ashley Akin, a certified public accountant (CPA) and senior tax associate at RKO Tax in New York City. “Even with its torrid expansion slowing to a more sustainable 5-5.5% pace in 2024 projection, that figure still dwarfs economic outputs across most of the globe.”

The country’s massive middle class and rise as a global innovation leader also present potentially lucrative investment opportunities, particularly in consumer goods, technology and health care services.

That assumes China can get out of its own way and focus more on growing its economy than insularly pushing for more security and secrecy.

“Realizing those lucrative rewards requires stomaching an elevated risk profile most international investors aren’t accustomed to,” Akin said. “China’s unique market landscape is shaped by Beijing’s heavy hand in orchestrating policy directives and industrial priorities. What seemed like a can’t-miss opportunity one year could rapidly fall out of favor with regulators the next as social and political objectives shift.”

Akin pointed to how swiftly the government’s crackdown on private education companies and internet platforms unfolded in 2021 and the persistent overhang of geopolitical tensions with Western nations impacting trade flows and market sentiment. “The Chinese economy is anything but a free market in its purest sense,” she added.

Still, there are good investment opportunities in China right now, with Ye boosting these investment sectors:

• Technology giants: While facing regulatory pressure, “Tech companies with strong innovation potential are still attractive in the long run,” Ye said.
• Green energy: China’s push for sustainability makes renewable energy, electric vehicles (EVs) and related sectors “more promising,” Ye noted.
• Consumer goods and services: The growing Chinese middle class drives demand in the consumer goods sector, even as most China households are hunkering down until the economy improves. Boston Consulting Group estimates almost 40% of China’s population will attain “middle-class and affluent consumer” status by 2030.
• Health care: An aging population, coupled with rising incomes, “fuels growth” in the health care industry in 2024, Ye added. The World Health Organization (WHO) forecasts that 28% of China’s population will be over 60 years old by 2040.

Risks of investing in China

Risk assessment should be job one for investors considering pouring assets into the region.

“Doing your diligence on investing in China is critical,” Akin said. Before allocating any capital, she advised deep diving into the following country issues and impactors:

• Government policies: Get a solid grasp of Beijing’s current priorities across different economic sectors and how policies may continue evolving, for better or worse. Disruptions come swiftly.
• Market access: Certain industries, particularly semiconductors, quantum computing and artificial intelligence (AI), face outright restrictions on foreign investment or ownership. Understand which markets are realistically open to international capital.
• Transparency: While improving, China still lags behind developed markets in corporate reporting standards and information transparency. This makes performing proper due diligence exponentially harder.
• Currency risks: The value of China’s currency, the yuan, can fluctuate unexpectedly against global currencies, introducing potential volatility that could erode returns for international investors.
• Political risks: China’s economic priorities are intrinsically linked to its domestic and international political ambitions. Don’t ignore how geopolitical tensions could impact your China portfolio.

Regulatory changes, particularly in sectors like technology, can also significantly impact investor sentiment and company valuations.

“Geopolitical tensions between China and other countries, such as the US, can also introduce volatility and affect market performance,” said Olivia Tian, a Chinese native, investor and current marketing director at San Diego, California-based Raise3D, a 3D printer manufacturing company. Moreover, concerns about corporate governance practices and transparency in Chinese companies could pose risks to investors.

Strategies for investing in China

US-listed Chinese ADRs

Far and away, buying and selling Chinese stocks via American Depositary Receipts (ADRs) listed in the US, including high-profile companies like Alibaba (BABA), Baidu (BIDU) and PDD Holdings (PDD), is the easiest way to invest in Chinese stocks.

An ADR enables US investors to buy securities registered outside the US as if they were American publicly traded companies and investment funds. Usually, any US brokerage firm markets ADRs to its customers in a straightforward fashion, allowing investors to purchase US-listed Chinese stocks just as they would any other US stock.

Although Chinese companies listed internationally typically have better corporate governance and reporting standards than locally traded stocks, investors still need to do the homework, which should include a deep dive into a company’s financials, management and competitive standing in its sector. “If you don’t have the expertise or risk tolerance to select individual securities yourself, work with an investment manager experienced in navigating the intricacies of the Chinese market,” Akin said.

A good “first step” is researching companies in China’s relatively thriving technology and manufacturing sectors.

“Companies like Tencent, Alibaba and Huawei continue to demonstrate resilience and innovation, offering long-term growth potential,” Tian said. “Similarly, the manufacturing sector, including electronics, automotive and consumer goods, remains a cornerstone of China’s economy and presents investment opportunities for established and emerging companies alike.”

Note that you can also buy leading China-focused exchange-traded funds (ETFs) listed on US exchanges.

Pros:

• Buying Chinese stocks already listed in the US gives you an indirect path to the Chinese investment market.
• Your current US brokerage firm (or any major brokerage firm) may offer access to China ADRs.

Cons:

• Researching Chinese stocks and funds can be more complex than with US stocks, as regulatory and compliance reporting metrics and standards are different between the two countries.
• Given the increasingly hard-line public policy confrontations between the US and China, and the latter’s volatile economy, Chinese ADRs have been delisted from trading exchanges before, and that could easily happen again.

Invest in Chinese stocks directly

Some non-resident investors may be able to open brokerage accounts that allow for direct investments in Chinese stocks. However, doing so comes with additional, unnecessary risk and the need to jump through a lot of regulatory hoops, so it’s not recommended. Even for professionals, significant research and due diligence is required, as China is unique in multiple ways as an investment haven.

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“For instance, over-competition is always an issue for Chinese stocks,” said Bin Xiao, a portfolio manager at Polaris Capital Management. “We are very cautious about any company that faces fierce competition with no rational return.”

While China’s corporate governance culture is slowly changing, many management teams focus only on raising capital. “They don’t care much about return on investment or shareholder-friendly initiatives,” Xiao said. “At Polaris, we add a higher discount rate to accommodate these risk factors.”

Xiao said his firm is interested in local technology companies, especially software and hardware in high-tech sectors and manufacturing within China.

“We’re equally attracted to Chinese companies with a global footprint, namely with supply chain relocation and/or manufacturing facilities in advantageous locales,” he said. “On recent travels in China, we noted that several Chinese companies moved final assembly to other low-cost jurisdictions like Mexico, India and Hungary.” Xiao called this “an intriguing prospect” and “one that minimizes labor costs, time-to-market,” tariffs and even some geopolitical risk.

Polaris also believes that Chinese companies in the EV, battery and renewable energy space are of particular interest, as both Europe and parts of the US have delineated clean energy commitments (Europe wants to be 100% carbon-neutral by 2050; California by 2045).

“To meet the target timelines, they must partner with China,” Xiao noted. “The West can’t compete with current Chinese automation and concurrent cost efficiencies. We expect some of the bigger EV and green energy players in China to start building manufacturing facilities in Europe; once EVs are made on European soil, the price to market (without shipping, etc.) will be very competitive.”

The takeaway on investing in China

Reaping the rewards of the world’s second-largest economy isn’t easy, but the profit potential can be abundant.

“For investors willing to embrace the unique challenges, the long-term Chinese growth story still has plenty of chapters left to unfold,” Akin noted. “Prudent portfolio allocations sized appropriately for your individual risk tolerance could be rewarded for decades to come.

”Portfolio investors should also aim for a diversified, long-term approach that blends Chinese equities, fixed-income securities, ETFs and tangible assets, like real estate, when feasible. “But avoid over-concentrated bets on niche companies or sectors subject to volatile policy shifts,” Akin said.

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