Why active management pays in China

Big name Chinese equities including Tencent, Alibaba and JD.com dominated global equity strategies until late 2020. Almost every well-known fund manager in the country had significant weightings to the region on the basis that it had continued to grow strongly during the pandemic and had a strong economic backdrop in the years to come.

Naturally, the Chinese Communist Party’s decision to implement their ‘common prosperity’ campaign came as somewhat of a surprising for the less experienced investors in the region. According to Tom Goodrich, Senior Investment Analyst at Zenith, the policies were “introduced to ultimately shape Chinese society to be more equitable through closing the wealth gap.”

The education sector wasn’t the first sector to be hit by sweeping regulatory changes, but it provides a case in point in relation to the power of active management in fast growing economies and sectors.  In late July 2021, said regulatory changes ‘sent shockwaves through equity markets’ according to Goodrich.

“The world took notice of the regulatory changes, with Chinese education giants New Oriental Education and TAL Education being two of the many Chinese after-school tutoring names experiencing a massive spike in interest on Google.” Both share prices suffered precipitous losses due to the government crackdown which included

• Holiday curriculum tutoring being forbidden
• Online tutoring of children below six years old is forbidden
• Foreign businesses are prohibited from acquiring or holding shares in after-school tutoring entities

Ultimately the result was a significant portion of their revenue ‘evaporating’ overnight. Despite suggestions that this sort of change was ‘unprecedented’ history has shown it has and will continue to happen regularly. Whether it is ballooning commodity prices, infant formula, or even video gaming, which attracted the attention in September 2021; anything capable of influence the equality of the Chinese population could be under the microscope.

This shouldn’t make China ‘uninvestable’ as many now suggests, rather it means investors need to be “ahead of the curve and identify changes before they happen”. Goodrich says successful active managers can often avoid sectors that may come under pressure, which was the case with the most recent education changes.

With New Oriental and TAL Education in focus, Zenith found that 75 per cent of their rated managers were able to avoid both in the 12 months before July 2021, whilst 62 per cent of funds that held them had exited before the selloff. That is in stark contrast to the index tracking strategies.

Concluding, he says “we believe this is a strong case study for active management, with the majority of our active managers successfully navigating the recent regulation-induced market turbulence and others avoiding the ill-fated companies entirely.”

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.