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Video Transcript

China Growth Spots in 2016


TOM BUTCHER: David, China's been all over the headlines. Could you tell me what the real story is?


DAVID SEMPLE: You're right, Yes, there have been some very sensational headlines driven by outlets that are obviously driven by eyeballs. The truth is much more nuanced. There are certain things that you should be worried about, and certain things that you should not be worried about. There are still some fundamentally great opportunities to invest in in China, once one understands where China is going and how it's changed from in the past.


The focus has been primarily on China’s currency, which has moved from effectively a bilateral peg to the U.S. dollar to a much more sensible trade-weighted basket basis -- a sort of dirty float, if you like, against a trade-weighted basket [a “dirty float” is a currency that floats in value in terms of other currencies but is not free of government intervention.] Ultimately, this makes much more sense for an economy as large as China’s. It doesn't just trade with the U.S., which is not even China’s largest trading partner. So, to be linked to the U.S. dollar particularly as you enter a U.S. tightening cycle, albeit elongated, doesn't make any sense. The nature of every peg is that it engenders bad behavior from corporates in terms of carry trades, borrowing in U.S. dollars without any either natural hedges or explicit hedges for that borrowing in another currency. And unless you've got a currency support system like Hong Kong, pegs break over time. You don't want to encourage that behavior. Putting into place some volatility and a more sensible targeting system makes a lot of sense in China.


That being said, as you move anything off uncertainty, it spooks markets. And this is at a time where there is clearly some concern about the commodity complex. There's even some concern about the U.S. economy. This has all been grist for the mill for nervous investors, and has meant heavy focus on China in terms of its currency. We think that China’s currency will modestly depreciate against a basket of China's trading partners. And if you want to know how that impacts the U.S. dollar-RMB exchange rate, you have to tell me where the U.S. dollar is going, against the G3 currencies in particular. That may well be upwards. We’ve seen continued dovish comments from the ECB, and that may well mean that the euro will enter into a weakened period.


What you do want to focus on in China, if you have concerns, is how China is going to mop up the excess leverage in its system. There are certainly ameliorating factors in this, in which a lot of the debt is actually run through local governments, and local governments are different from your average corporates, even though it appears as corporates in terms of classifications. Nevertheless, there has to be some creative destruction amongst the zombie type of companies, those companies with excess capacity. How the Chinese government is going to deal with this is still somewhat up in the air and is likely to create some headlines going forward.


It's a balanced picture, but underlying this has been a fundamental shift in China’s economy, away from the old smokestack SOE type of complex into the so-called new China, which is emphasizes clean air, clean water, clean food, clean governance, education, healthcare, and tourism. Those things are important now. Our investment process leads us to be invested in these new economy type companies.


BUTCHER: David, where do you see potential growth spots in China? You mentioned tourism. Do you see tourism as one of the growth spots in China?


SEMPLE: Yes, it is absolutely a growth spot in China. As people have more disposable income, that are searching for new experiences, and no longer just focusing on the basics of life. You have enough food, you have a house; what are you going to do? You want experience what the rest of China and the rest of the world has to offer. Just go to the main tourist sites in Europe, for instance, and you will understand the impact that Chinese tourism is having. Looking at the outbound travel statistics from the major airports, such as Beijing and Shanghai, you can see a very solid structural growth in tourists exiting the country.

China is the largest external tourism market in the world. Perhaps some of that is for arbitraging cheaper goods. For example, you can buy a Louis Vuitton handbag cheaper in Paris than you can in Beijing. It's partly due to tariffs and it's partly just due to, obviously, geography. The Chinese people want to experience what the rest of the world has to offer, and that's been reflected in growing tourism statistics.


BUTCHER: E-commerce also appears to be quite a hot topic.


SEMPLE: It is a hot topic, and with China, it’s very mobile-driven. The percentage of smartphone penetration in China versus GDP is an outlier, meaning more people have smartphones. There has been something of a major technology leap there, meaning that people start using their smartphones to do whatever smartphones can do, including e-commerce, rather than getting used to using desktops first.

There clearly are some champions emerging in the space, and these large companies are investing very heavily in the offshoots resulting from this, both online and offline. For example, ordering food or ordering taxis, which are clearly very important. This means that companies’ margins might be depressed in the shorter-term because of the sheer scale of the new opportunities available to invest in, which makes them appear quite expensive. Some of these offshoots are not even generating a bottom line profit right now, but we feel very strongly that these represent great structural growth stories.


BUTCHER: Are there any other areas in addition to e-commerce and tourism that spring to mind?


SEMPLE: Environmental is a very interesting place for us. It’s all about cleaning up the nasty environmental stuff in China; the dirty water and air. Part of this is reducing the output that's required from thermal energy and making it more efficient, but also implementing alternative sources of energy, such as solar, wind, and so forth, which are very much the focus of further investment in generating electricity in China.


BUTCHER: As incomes increase and the middle class gets bigger, is there more emphasis now upon people buying their own health care?


SEMPLE: Yes, in common with a lot of emerging markets countries, public health care leaves something to be desired. The number of beds per a thousand people in China is relatively low. The provision of health care is spotty; some is good, some is bad, in public health care. But what is happening is that most Chinese with higher disposable incomes want to have better health care, and as they need better health care because they're getting older. The Chinese, in many areas of the country, are getting more prone to Western type of diseases; they're getting heavier, and that results in more cardiovascular disease and diabetes, for example. The availability of drugs has also increased, and is clearly a political imperative for every country around the world, but certainly for the emerging markets. The availability of relatively cheap drugs, including generics, is very important in this context.


BUTCHER: David, thank you for your time.


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