November 13, 2020

It’s been a roller coaster of emotions for investors this week. Our focus is China. China of course is where COVID-19 originated in late 2019. It felt the impact first. It shut down vast swathes of its economy in response and it is now coming out of it, first. All indications are that the world’s second-largest economy, by some measures occasionally the largest, is making a comeback. It looks like an impressive one.

The International Monetary Fund is predicting China’s economy will expand 1.9% this year, and estimates it will be the only major world economy to show any growth.

This week’s guest says that China’s economy is well on its way back to normal and that means there are multiple opportunities for investors in the world’s second-largest stock market.

Robert Horrocks, Ph.D. and Chief Investment Officer of Matthews Asia on how back to normal is China? We will find out.

WEALTHTRACK Episode #1720; Originally Broadcast on November 13, 2020

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Combined Chinese Stock Markets Second Largest in World

China’s A-share market:

  • Chinese mainland-based companies trading on the Shanghai and Shenzhen exchanges
  • Gradually opening up to foreign investors

More A-shares being included in major indexes including MSCI Emerging Markets indexes

Morningstar’s Gold and Silver Medalist China Region Funds

  • Matthews China Investor MCHFX – Gold
  • Matthews China Dividend Investor MCDFX – Silver
  • Matthews China Small Companies MCSMX – Silver

No Bookshelf titles this week.


Own some Chinese A-share Stocks

  • Use actively managed funds choosing individual stocks
  • Offer participation in China’s growing private sector


WXXWY data by YCharts

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CM: This week on WEALTHTRACK, China's comeback.

RH: You're seeing a big boom in some of the IP related industries. Now, health care has been one where you're seeing real innovation in therapies in China now and real competition on a global scale for some new drugs, new molecules to treat lifestyle diseases. And that's been a big change that has probably impacted the markets relatively strongly only in the last two or three years.

CM: Matthews Asia's Robert Horrocks makes the investment case this week on Consuelo Mack WEALTHTRACK. Watch it on your local public television station and on

Announcer: Funding provided by Morgan Le Fay Dreams Foundation, ClearBridge Investments, Royce Investment Partners, Matthews Asia, First Eagle Investment Management and Stategas Asset Management.

CM: Hello and welcome to this edition of WEALTHTRACK. I'm Consuelo Mack. This week our focus is China. China, of course, is where COVID-19 originated in late 2019. It felt the impact first. It shut down vast swaths of its economy in response and it is now coming out of it first. All indications are that the world's second largest economy, by some measures, occasionally the largest, is making a comeback. And it looks like an impressive one. Third quarter GDP, up 4.9 percent after 3.2 percent growth in the second quarter. And a devastating for China and historic 6.8 percent contraction in the first quarter when the full force of the pandemic was felt. Its benchmark unemployment rate fell to 5.4 percent in September from 5.6 percent in August, both down from February's record 6.2 percent rate, the worst of the shutdown. The International Monetary Fund is predicting China's economy will expand 1.9 percent this year and says it will be the only major world economy to show any growth. Well, this week's guest says that China's economy is well on its way back to normal and that there are multiple opportunities for investors in the world's second largest stock market. He is Robert Horrocks, PhD and Chief Investment Officer of Matthews Asia. Launched in 1991, the firm was one of the first American mutual fund companies to specialize in Asia. It is now the largest, with nearly 24 billion dollars in assets under management. Horrocks is also Portfolio Manager of two mutual funds. Full disclosure: Matthews is also a WEALTHTRACK sponsor. Well, how back to normal is China? That's where we started our conversation.

RH: Yeah, how back to normal is China? Most of the way I'd have thought if you look at just general economic activity, I'd say it's probably 80, 90 percent back to where it was pre-COVID. If you look at anecdotal evidence around the cities, the way that people are living their lives, it's pretty much back to normal. If you think about the industries involved, I mean, obviously, the export sector will have been hit a little bit by the downturn in activity in places like Europe and the U.S. But as we know, that's not really that important for the Chinese economy anymore. If you look at monetary and fiscal policy, they haven't had to do a lot. You haven't seen the big stimulus spending, the big emergency packages that you've seen in Europe and the U.S., and that's another indicator that they got the virus under control quickly.

CM: How is it that China has gotten, number one, the virus under control so quickly? What have they done right? And also that they have been able to jump-start the economy and have it, as you said, back to almost 80 percent. I know domestic airline traffic, for instance, I just got this figure before we did the interview, is up to 80 percent of normal in China. So things are rolling.

RH: Well, how have they done it? Number one, they're used to it. They have outbreaks of viruses in China pretty much annually and automatically everybody knows what you need to do, to wear the masks, to be careful about interactions. They have a government that is also used to imposing these lockdowns very quickly in a very disciplined manner. And people generally listen to what the government says. So there is a sense of execution and experience in dealing with these issues. I think there's an interesting angle here as well, though, in why have things gotten back to normal so quickly is because, in a way, the Chinese live a more virtual experience than we do. We're still getting used to mobile phone shopping and online shopping. We might think that we're the center of the universe here in the U.S. as doing that. But we still have a lot of habits of going down the high street, a lot of habits that are brick and mortar, whereas the Chinese, because they leapfrogged that stage of development, they're much more used to this virtual lifestyle where you pay on your phone and you have these virtual experiences. So in that sense, they were never put that much off the rails by this pandemic in the first place.

CM: The fact that China has not been as affected economically as many other developed economies, that's interesting. And Matthews Asia has been covering the transformation of the Chinese economy from a manufacturing and export-driven economy to a consumer-driven economy. So can you tell us where China is in that stage of the transformation of the Chinese economy?

RH: This is something that has been creeping on for years and years and years now. And so you now see in the data that the service sector actually adds more to GDP than the manufacturing sector does there.

CM: And how much more, Robert? I mean, what is the shift in the mix been?

RH: In terms of adding to productivity, it is probably adding more than half of the productivity gains in any given year at the moment. So it's around about 40 to 50 percent of GDP that it's contributing …

CM: Is consumer now.

RH: And services, yes.

CM: Right.

RH: So it is now a domestic consumer services-led economy. You're seeing a big boom in some of the IP related industries. Now, health care has been one where you're seeing real innovation in therapies in China now and real competition on a global scale for some new drugs, new molecules to treat lifestyle diseases. And that's been a big change that has probably impacted the markets relatively strongly only in the last two or three years.

CM: Those are high-end products, right? And they're being manufactured in China? Developed in China?

RH: Yeah, in some of the more innovative therapies where you're manipulating the body's own immune response to attack things like cancers, there are probably more trials going on in some of these high-level therapies in China than there are in the U.S. for example. You have all sorts of questions over the way the trials are run and the validity of the data and the way it's organized. And so can they naturally translate into globally competitive drugs at the moment? Well, there are some issues there. But for sure, we have some candidates to be world-leading therapies and they're coming out of China. And for the first time, really, as an investor, you're able to access these companies through the public markets.

CM: So these are the smaller, more innovative companies. Some of them are publicly traded and accessible to investors.

RH: They are, but some of them are not so small anymore. I mean, they're tens of billions of dollars now, particularly in contract manufacturing, to make these molecules and to help these smaller companies go through the testing process. These are much more scalable businesses. So you do have some very large cap names there as well.

CM: Can you give me some examples or an example?

RH: Well, one company, I think that is quite well known is called WuXi Biologics, which is a company that helps manufacture the molecules for innovative companies and get them up to scale and get them through the process.

CM: One of the concerns about China's economy is the state-owned enterprises and the clout and the power that they have within China's economy. That is another transformation that Matthews has been covering for many years now. Can you tell us where China is in that transition?

RH: Yeah, they're a long way through that transition from state-owned to private enterprise to state-owned enterprises and maybe a quarter to 30 percent of GDP these days. And yes, the state-owned enterprises do get easy access to bank loans. And many of these bank loans are there just to prop up these traditional state-owned enterprises. But I have a very particular way of thinking about this. So I was born in the northeast of England. And when I was a young boy, Margaret Thatcher got elected. And the northeast of England is a place where you have coal mines, steel mills, shipbuilding, all these traditional industries. And she just shut them down. They weren't profitable. She wasn't going to keep them open. And that led to the miners' strike and a lot of political upheaval and unrest in the northeast. Well, China looks remarkably similar. The northeast of China is dominated by steel, by coal, by shipbuilding, all of these heavy industries. But rather than shut them down like Margaret Thatcher did, because they don't want the social unrest, they have this sort of supporting system through the banks that keeps people employed and they can retire these businesses and these workers gradually. So really, it's like a welfare state. But it is one reason why you have to be cautious about the commercial viability of some of the Chinese banks. I don't mean in an insolvency sense, but really, how commercially run are they? And you have to be concerned about also the long-term viability and sustainability of those state-owned enterprises. But it's not something that worries me from a macro perspective, because the Chinese know that the future lies in the new industries and in the entrepreneurs and the small and mid-cap businesses that are now growing very quickly outside of this state welfare system.

CM: Let's talk about investing in China. Chinese stock markets combined are the second largest stock markets in the world. And there have been some major changes there as well, where it used to be very difficult for foreigners to, if not impossible for foreigners to get access to what are called the A-shares. These are Chinese-based companies that trade on the local exchanges. Those are now being liberalized, opening up. Where are we in that change?

RH: I think we're in the first sort of phase of it, or maybe the second phase. The first phase of the Chinese A-share markets was just list as many companies as you can. And they did that over many years. This second phase is more about, well, now we need to deal with the quality of those companies, because although we think the A-share market is one of the greatest opportunities for investment in the world today, it is undoubtedly one of the worst quality markets in terms of the average quality of the companies on it. And if you just take a very simple measure like return on capital, does your return on capital beat the cost of capital? In other words, should you really exist as a long-term business? And about 70 percent of Chinese A-shares fail that test; 70.

CM: Wow. All right.

RH: So there's 30 percent that pass that simple test. But it's such a huge market that 30 percent equates to nearly a thousand companies. So there is a lot that has to be done to raise the average quality of companies. But it is a good market for people who do the research, do the stock picking and can find those well-run businesses that are making a profit. This capital market reform is one of the premier objectives, maybe the most important domestic policy initiative for the Chinese government, and they're going to be focused on the bond market first. They look at the U.S. and say the U.S. has one great advantage is that everybody is willing to hold its U.S. Treasuries. And we would love to see that. We would love to have a world where people would be agnostic between holding U.S. Treasuries, German Bunds and Chinese Government Bonds. So they'll do a lot to raise the profile of that market, to develop international trust in that market, and the equity market will then follow suit from that.

CM: Where are they in that process?

RH: Well, you put your finger on it just earlier. Access is the first thing that they have to do, granting access to people so that they can get in there, they can look at these companies, they can understand the markets. The Stock Exchange, for example, does much more of a regulatory role in China than it does in the U.S. and that's partly because of this desire to develop trust. If you want to raise capital in the Chinese stock markets of a significant amount, actually, the stock exchange will also ask you to justify that. You can't just raise it and have the investors argue over it. So they're trying to develop that trust both within the domestic population and the foreign population in their capital markets. Now, how long will it take? Other countries took decades to succeed. The Chinese normally do things faster and have a track record of succeeding at these things at a much faster pace. So it's probably a policy that they hope to succeed in over the next 10 years or so.

CM: It's fascinating. Let's talk about stocks, which is what Matthews Asia's specialty is. And, you know, I never think of China as being a place where I'm going to invest to get dividends. Talk to us about why Chinese companies are a good place to get dividend-paying stocks.

RH: China is a good place to employ a dividend methodology. It's a slightly different dividend methodology to what people normally associate. It's not one based on the income you get from the dividend, but rather what that says about the quality of the growth in the business. We like to own companies that pay a dividend. The paying of the dividend really tells you what they think about you as a minority shareholder. So it's a governance issue. There are plenty of companies that have enough cash to pay a dividend, but they don't. And that tells you what they think about you. So the mere fact that the company pays the dividend tells you that it can and it will. Now, the next thing we look at is we look at the growth in that dividend and that dividend stream. What's the track record? How fast has it grown over time? How fast do we think it can grow in the future? And that gives us a total return idea that this company, while it's paying two percent, we think it can grow at ten. So that would be a total return of 12. And then we think about the risk profile of the company. And you can balance the portfolio between companies that pay a little higher dividend, growing a little bit more slowly, but with a lower risk profile than companies that pay a lower dividend but growing much faster, but have a slightly higher risk profile. And that allows you to try at least to put together an all-weather portfolio. It's not going to swing up as much on the upside and it's not going to, hopefully, do as badly on the downside in markets.

CM: You know, it's interesting that you say that it shows that they care about the minority shareholder. I mean, a lot of the small cap companies in Europe, for instance, are just large cap companies in Europe. Many of them started out as family owned and they still have minority shareholders who are families. And so therefore they are paying dividends because the families, the owners want them. Is there that same sense in China? I mean, are a lot of these companies family owned and therefore their family shareholders want the dividends and therefore there's a commitment to it?

RH: Absolutely right. Totally right. And in fact, it's an even higher percentage in the Asian and the Chinese markets than it would be in Europe. It's quite common to see these family businesses where either the family is still in control, so they extract the money that way, or they've handed it over to professional management, and the dividend is a way of keeping one hand on the shoulder of the management and keeping them honest. Dividends developed partly to get value out of the business and partly to bridge a trust issue between the people running the business because they have all the information and the shareholders in the business who are not privy to the same information.

CM: I've been talking to portfolio managers of Matthews Asia for many, many years since your founding. There was real caution on Matthews Asia's part about investing in China because it was kind of like the Wild West and it wasn't well regulated and there was a lot of questionable practices going on. Do you have much more confidence now in investing directly in Chinese companies?

RH: Yeah, it's been really a very dramatic change. I mean, from my first time in China, which was actually even before they had a stock market in the late 80s. And just to see the way that the economy has changed, people's attitudes have changed, government policy has changed, first and foremost. They were just then coming from a centrally planned economy to something that was embracing the market. And now they've seen the success of embracing the market in China. I mean, back in 1990, maybe about three-quarters of the population would have lived in households that earned less than two dollars a day. That's right down to five percent now of the population. This is such a massive achievement on humanitarian grounds. But also, such a massive achievement for the Chinese Communist Party that they understand that embracing the market has led to social stability and has led to them prolonging their role. So, yeah, they know this is important. They know the financial markets are important. They're doing the best that they can to clean up the companies, to improve the quality, to incentivize management, to have better corporate governance. It's a real focus of theirs. And I would say that and along with much better access, has really accelerated in the last five, six years to a point where it's not unusual for a China portfolio to have a quarter or a third of its portfolio coming from those domestic A-share markets and even regional funds, 10, 15 percent.

CM: What would you advise individual investors now as far as what their focused China exposure should be?

RH: I think they should look at a focused China exposure. I mean, you're talking about China now being nearly 50 percent of the Emerging Markets Index and far less than that in the EAFE, I think in some of the World ex-U.S. benchmarks, it might be 10 to 13 percent; a lot of that will be Hong Kong. I do think it's time for people to consider a separate China exposure because it's only going to creep up in these emerging market benchmarks. It's only going to become more important in the global benchmark. So thinking about it separately does make a lot of sense. And I think the advantage to that from a portfolio perspective is that you should, if you're focused on domestic China businesses, you should enjoy less of a correlation with what's happening in Europe and the U.S. So there might be some balancing effects. And in a way, the world seems to be moving to this situation where you have the U.S. and Europe and China and these three kind of centers of influence. And it may even be that it's just the U.S. and China that end up being the two big centers of influence fighting over Europe. So in that sense, you're also matching the way that global politics seems to be moving. So I would say to investors, look for the possibility of doing a separate China portfolio and think about how you want to approach it, how aggressive you want to be, what your risk tolerance is, and you can now find those portfolios that can match your individual risk tolerance.

CM: How do you feel about our exposure to China through indexes?

RH: It's very difficult for the index providers with China. As I said, the wheat and the chaff. Well, it's about 70 percent chaff and 30 percent wheat. And the wheat isn't always the big mega cap stocks. I mean, I gave a few of my concerns over the commercial aspects of the Chinese banking system. These are huge companies, so they're naturally big representatives in the indices. And the way that the indices are put together in a systematic way, they can't get around that. So I do think that there is a great scope for stock picking in the A-share market. And I think the benchmarks are going to struggle to find the best exposure in A-share markets for some time now because they're bound by the systematic rules.

CM: And, Robert, the question we ask everyone at the end of every WEALTHTRACK: What would you have all of us own some of in a long-term diversified portfolio?

RH: Well, you should own some A-shares. You do have a choice out there in the world of looking at these Chinese portfolios, see how exposed they are to A-shares. There may even be some pure A-share products that are interesting too, so long as they're done on a stock-picking basis. But I think everybody should start looking at China separately and they should start investigating how they get exposure to that domestic market – and that means A-shares.

CM: All right. We'll leave it there. Thank you, Robert Horrocks so much for joining us on WEALTHTRACK.

RH: Thanks, Consuelo. Always happy to.

CM: At the close of every WEALTHTRACK, we try to give you one suggestion to help you build and protect your wealth over the long term. This week's action point is: Consider adding some direct Chinese exposure to your portfolio through an actively managed China fund. The combined Chinese stock markets are the second largest in the world after the U.S. China's A-share market of Chinese mainland-based companies that trade on the Shanghai and Shenzhen exchanges has been gradually opening up to foreign investors. A-shares are also going more mainstream with the expanding inclusion in several major indexes, including the MSCI Emerging Markets indexes. As Horrocks told us, many A-share companies are speculative, but many are not, which is where active managers with a long history and track record of investing in China can find the best opportunities. Now Morningstar's gold and silver medalist funds in the China region are all managed by Matthews. They are Matthews China Investor, Matthews China Dividend Investor and Matthews China Small Companies Fund. A small allocation to direct investment in Chinese companies through knowledgeable and experienced money managers, gives investors participation in one of the world's largest and most dynamic economies and regions. Well, next week, a WEALTHTRACK exclusive: Timeless investment advice from Charles Ellis, the author of the investment classic Winning The Loser's Game, just published in its eighth edition. We'll find out what's changed. In this week's EXTRA feature on, Robert Horrocks will share how he managed his Asian portfolios while sheltering in place in the U.S. 

CM: Please continue to reach out to us on Facebook, Twitter, and our YouTube channel.

CM: Have a fabulous weekend and make the week ahead a healthy, profitable, and productive one!

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Matthews Asia’s Chief Investment Officer Robert Horrocks notes there have been expected challenges and unexpected benefits to managing their Asian portfolios remotely.

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