China’s talk of reform leaves investors cool toward state giants

China’s talk of reform leaves investors cool toward state giants

5:02pm EDT

By Umesh Desai and Vikram Subhedar

HONG KONG (Reuters) – For all the grand talk of far-reaching reforms when China’s leadership meets early next month, foreign investors have refused to become carried away, with most choosing to shun the country’s mammoth state-owned enterprises (SOEs). The new leadership has been in place for a year, and investors are keen to see its strategy to keep the world’s second largest economy growing, as it enters a more mature phase of slower expansion.State-run news agency Xinhua reported on Tuesday that the Communist Party Central Committee should discuss “a new historical beginning that comprehensively deepens reforms” when it meets behind closed doors on November 9-12. And a senior Politburo member has promised “unprecedented” economic and societal reforms were on the agenda.

But investors harbor doubts over how far China’s leaders will go to shake up SOEs in desperate need of reform.

“They have been long on talk and short on execution,” said Dilip Shahani, HSBC’s Hong Kong-based head of global research.

“They have highlighted industries where there are excesses, but such consolidation requires takeovers, liquidations and these are difficult to achieve in China.”

State firms are riddled with issues like excess capacity, and poor corporate governance, and they have struggled to meet the challenges posed by China’s shift towards more consumer-led growth.

Some, like those in the oil and gas sector, are considered prime candidates for an overhaul because they are simply too big. Others may be spared drastic action.

But investors are reluctant to take positions until Beijing’s intentions become clearer.

SOEs dominate market capitalization in almost every sector, and global investment managers cannot duck taking a view on them altogether. For the past two years that view has been overwhelmingly bearish.

There are some early signs of a divergence, however. While investors remain cool to Chinese SOE debt, some appear to be warming up to opportunities in equities.


Large bond supplies from SOEs and prospects of the U.S. Federal Reserve withdrawing its multi-year campaign of quantitative easing are deterring buyers of Chinese corporate debt.

Another reason why some are averse to investing in SOEs can be their sensitivity to policy shifts in Beijing.

“Even if you like a company, a change in government policy can completely upend your positions,” said a fund manager at a U.S. fund in Hong Kong that manages more than $5 billion in Asian debt. “You are better off getting value from other investment grade names in Asia.”

An index that measures the performance of emerging market investment grade bonds compiled by JP Morgan shows an indicative yield of 5.7 percent, according to Thomson Reuters Datastream.

By comparison, China National Offshore Oil Corporation, a proxy for the China SOE space, has a bond maturing in 2023 yielding just 4 percent.

With benchmark U.S. Treasury yields up nearly a percentage point from May’s lows and set to rise further, it becomes even harder to justify investing in SOE bonds at these levels.

There is also no scarcity of supply.

Bond issues by China’s SOEs have notched a record, with more than $25 billion issued since the start of the year, accounting for a fifth of total new issues in Asia, excluding Japan, according to Thomson Reuters data.


But viewed through the equity lens, China’s SOEs are starting to become attractive even though its state-owned banks, which dominate this space, have been riven by concerns over bad debts, shadow banking and growth in wealth management products.

Investors have begun taking notice of a yawning valuation gap – in some cases at multi-year highs – between SOEs and private companies, such as those in the technology and gaming sectors.

The gap between the price-to-earnings ratio for a basket of the biggest private companies in Hong Kong/China and for the SOE-heavy MSCI China index is at its highest in more than five

The top three most underweight stocks in global fund managers’ Asia-focused portfolios are China’s state-owned firms – China Construction Bank (0939.HK: QuoteProfileResearchStock Buzz), ICBC (1398.HK:QuoteProfileResearchStock Buzz) and China Mobile (0941.HK: QuoteProfileResearchStock Buzz), according to Bank of America Merrill Lynch.

While the most overweight stock across Asia is Chinese internet search firm Baidu (BIDU.O: QuoteProfile,ResearchStock Buzz).

“Global and dedicated investors are exceptionally underweight the unpopular state capitalist sector (SOEs), and egregiously overweight “growth-oriented” consumer, internet, telecoms names,” said BofA-ML’s Ajay Kapur in a note.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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