US president Donald Trump has done everyone a huge favour, including the Chinese, by getting Beijing to realise that their “imitate and steal” business model was not sustainable and it was time for the nation to switch to an “innovate and create” approach, according to Origin Asset Management John Birkhold.
Speaking at Investment Magazine’s Equities Summit, the fund manager’s comments came amid reports that US and China were close to finalising phase one of a deal which should pause the escalation of hostilities between the world’s two largest economies.
“Trump pointed out that China is not a place for an external investor to make money,” Birkhold said. “He has said increasingly, the impact of the state will diminish, animal spirits will emerge, creativity will flow, and everyone will flourish.
“There are a large number of world class companies in China which are bringing higher value-added services and goods to the table and they are the ones that will benefit from an open and transparent system.”
Birkhold said optimism about a US-China trade deal, coupled with a further interest-rate cut by the Federal Reserve, will increase the scope for emerging markets to ease rates. He said the stark truth was that markets delivered more growth but less profitability than developed economies.
“Historically, some of the emerging markets have focussed on growth for the sake of it,’ the portfolio manager said. “By growing lower-return businesses, all they do is destroy value and capital.”
In China, he said there was too much capital chasing low returns, which led to too much capacity and ultimately failure. Even so, Birkhold said market disciplines were starting to “kick in.”
“If you could just the state entity from allocating capital, China would be in a more sustainable position,” he said.
Birkhold said although markets like China, India, Brazil, Korea and Russia, do have some world-class companies, were characterised by a comparatively small number of large cap stocks and a lack of liquidity elsewhere.
Paul Crisci, a portfolio manager with IOOF, said his fund was overweight emerging markets as they are buying diversity. That said, he conceded that despite their low correlation with developed market stocks, correlations will rise with globalisation.
“You are (still) buying the drivers of global growth and assets with higher expected returns,” he said. He added that emerging markets have ample room to expand debt levels since they are much less leveraged than developed economies.
While the link between a country’s gross domestic product and stock market returns was tenuous, he explained that indices were dominated by old economy businesses rather than information technology, consumer and biotechnology. “This will change,” he added.
FTSE Russell’s Tim Bartho said as emerging markets move up the scale from frontier to advanced markets, regulators will improve governance to attract international investment.
“In advanced emerging markets, regulators are focussed on how minority shareholders are treated, whether their rights are protected and whether there are capital controls,” said the chief strategist of index policy for the Asia Pacific region.
Asked how long before China will be classed as a developed market, which is characterised by short selling, and derivatives, Batho said the problem came down to accessibility.
“The current inclusion is based on Stock Connect (a collaboration between the country’s three main exchanges) which doesn’t meet requirements of a developed market,” he said, adding that China has made a lot of headway in improving overall governance and transparency.
IOOF’s Crisci said from a relative-risk perspective, emerging markets were no riskier than US or Europe.
“US monetary policy has run out of gas, we’re seeing anti-capitalistic behaviour and in Europe there is political fragmentation and wealth gap issues.” He said investors should take a balanced approach and spread their investments bets rather than being overly concentrated in any one market.
