China’s long road to unwinding years of market and economic turmoil present an “interesting” tactical opportunity across equities and fixed income which can be accessed through ETFs, according to Will Bartleet, CIO at Pacific Asset Management.
Speaking to ETF Stream, Bartleet (pictured) identified two key forcing that have transformed investor perceptions of Chinese assets since 2020.
“The first is from an economic perspective, the real estate market – by some estimates 30% of Chinese GDP – the government started to address some of the debt issues with Chinese developers but it was already too late as they had already taken on huge amounts of debt.
“China decided to address this issue, knowing this would cause a slowdown, but knowing if they did not, they would risk a Japanese style bubble and then potentially lost decades.” Bartleet said.
While this signalled glaring red flags for China’s high yield credit market, the country’s equity market was also hampered by a raft of regulatory actions taken against the country’s largest tech companies.
“From a market perspective, the government took on China’s equivalent of the ‘Magnificent Seven’, which were incredibly dominant, profitable and had been leading the stock market.
“From there, those companies have fallen dramatically and more than a trillion dollars have been wiped off of their valuations.”
Playing the recovery with ETFs
However, Bartleet argued more than three years on, these dynamics are “well-understood” and as much as US and European regulators set about rewiring the western financial landscape following the Global Financial Crisis (GFC), there may be pockets of recovery opportunity in China.
On property market debt, he noted regulators have started to ease rules – such as the ‘three red lines’ – and local governments have started offering additional support.
To capture this trend, Pacific AM allocated to the Tabula Haitong Asia ex-Japan High Yield Corp USD Bond ESG UCITS ETF (TAHY) last November, when the ETF boasted an average yield to maturity of around 20%.
TAHY currently yields near 14%, with a weighted average duration of 2.5 years, a 36% China allocation and 20% allocation to the country’s property sector, which “has come down quite a lot”, Bartleet said.
“In a very quiet way, this sector has been rallying quite sharply since we bought it. From here, with yields where they are and low duration, we still think it is a very interesting way to play that recovery.”
He said the exposure remains interesting with yields still elevated and added its longevity is less about market timing and more about how yields continue to fall as prices rally.
On China tech equities, Bartleet said the firm allocated to the HSBC Hang Seng Tech UCITS ETF (HSTC) in January as the market showed “signs of real capitulation” and media coverage of the country being ‘uninvestable’ came to a head.
He noted the broad sector was trading at a premium to US tech companies in 2020 and now trades at “half those valuations”, even as earnings remain positive and earnings expectations have recovered slightly.
"It is a really interesting allocation – clearly extremely volatile – but everybody loved those companies prior to 2020 as they grew rapidly, they are still amazing companies and they still have a huge amount of growth to come from AI and they are finally incredibly cheap,” he said.
On the timeline for the HSTC trade, Bartleet said it is likely to be shorter-term than his team’s position in TAHY, owing to the potentially more tactical nature of the rally and regional equity allocations shifting away from emerging markets on a structural basis.
Overall, HSTC and TAHY currently comprise 1.5% and 1%, respectively, of Pacific AM’s balanced portfolio.
“We bought the ETFs as a pair, rather than just one allocation," Bartleet said. "When you look at the correlation between these two, it is very low – around 0.3 – and we think they address the two main issues in China that the government must solve.”
