From the moment the Russian tanks crossed the border with Ukraine, the world of investments changed. This is a war between two countries that mainly export basic products.
Russia is the world’s largest oil exporter: at the beginning of the year it produced 11.3 million barrels per day, according to the International Energy Agency. It was also the world’s largest exporter of wheat. Ukraine is another major grain producer. It exported 48 million tons of corn and wheat last year, according to S&P Global Dear. Both countries share the same largest market for their products: China.
With trade with Russia and Ukraine practically closed, commodity prices have increased globally. When the price of fuel and food rises, it often increases political risks in emerging markets, where these staples are a large part of many households’ daily budgets.
Wheat prices experienced a similar increase in 2010, when there were droughts in Russia and the Ukraine and severe weather-related problems in other grain-producing countries. The Arab Spring followed. Rising food prices were not the only cause, but they helped turn political tension into uprisings.
For a global equity manager, emerging markets can offer excellent growth dynamics when conditions are favourable. However, the history of investing in emerging markets is marked by occasional crises. Behind many of these there is usually a political history that begins beyond the borders of the affected countries.
Thus, for example, there is the current risk that Russia will not pay interest on its government debt. The last time this happened was in 1998 under Boris Yeltsin (the previous time was in 1917 after the revolution). 1998 is a bleak year in the memory of emerging market investors, as many Asian stock markets crashed. The collapse was probably due more to Brazil and Mexico defaults in previous years than Russia’s default, but a Russian default would bring back memories anyway.
Russia is still a small part of the investment in emerging markets. Earlier this year, it accounted for about 4 percent of the index compared to China at 32 percent, Taiwan at 16 percent, India at 12 percent, South Korea at 12 percent, Brazil at just 5 percent and others with 22 percent. . So China pretty much dominates the amount of exposure an investor might currently choose in emerging markets, especially if they are a passive investor.
Even before the war in Ukraine, China presented difficulties for international investors. Just under a year ago I wrote explaining why my team had decided to sell all Chinese investments in our fund. We had been monitoring how regulations had begun to change in ways that could impede shareholder value creation. We also noticed that the shareholders of major tech companies such as Alibaba and Tencent were not Chinese as the shares were listed outside the mainland and local investors could only invest locally. We were concerned that this would lead to scrutiny from Beijing.
In November 2020, the public offer of Ant Financial, the fintech side of Alibaba, was canceled at the last minute. This was expected to have been valued at over $35 billion, so a red flag was raised.
Over the next few months, a wide range of regulations and some fines were announced, hurting the value of other Chinese stocks, from food delivery to education and gaming companies.
Each announcement made sense in terms of taking care of the Chinese people, but many foreign investors inferred that the growth prospects of China’s most popular listed stocks had dimmed substantially. The target companies’ share prices plummeted.
We would not be brave enough to predict that this change in regulation is over. Demographics are arguably putting pressure on Beijing to go ahead with more action.
When I first started investing in China in 2002, there was an economic case for creating manufacturing jobs in coastal areas and allowing people to move off the land into these more productive roles. Foreign investment made it possible and was encouraged.
Two decades later, the one-child policy has left China with fewer young people to fill jobs and with a large population aging. China does not need foreign investment; you need money to pay social security. That likely means higher taxes, and profitable businesses are more likely to be tapped.
So how has the Russian invasion of Ukraine affected China? He has sided with Russia, but to date has avoided being drawn into the conflict. To be sure, Beijing has watched the effectiveness of Western sanctions on Moscow and noted how much worse such sanctions would affect its own economy.
Again, look at the trade data that highlights just how important China is as a part of the global economy. It exported $2.7 trillion worth of goods in 2020, according to the world Bank, and is the world’s largest manufacturer of mobile phones, computers, office machinery and clothing. The United States is by far its largest market. Neither country wants a sudden halt to trade.
How risky is investing in China for investors in general? A good litmus test is to ask yourself, “If you bought a stock and found that the rights of your shareholders were being abused, would you expect the local courts to uphold your rights?” You could also ask, “How likely is it that the stock market will close or the local currency will devalue sharply in times of stress?”
Very cautious investors will note that Russia closed its stock market as soon as the war began, rendering Western equity investments worthless. Some may recall that many stocks listed on the Shanghai index were suspended for a few weeks in 2018. The market had fallen sharply during trade disputes with the Trump administration in the US. Beijing currently appears to be trying to prevent a repeat of such a move. dispute. This is encouraging.
Indeed, some investors may be tempted by the very low valuations of Chinese companies. According to data from Bloomberg, the Shanghai stock market is trading at 15 times this year’s earnings and Hong Kong at 8 times. The US stock market is trading at 23x on the same basis. China’s economy is likely to grow faster than the US economy over the next 20 years, probably with less risk of inflation. So, in some eyes, current Chinese valuations offer an attractive “entry point”; and that may well be correct.
As a global equity manager, I have a wider range of options than managers specializing in specific regions or sectors. Although it is a major economy, I can dive outside of China. Other markets in the region can give me exposure to the higher growth rates expected in Asia, while allowing me to spread my holdings across different political environments. South Korea’s Kospi index is trading at 12x gains and Taiwan’s at 14x gains.
A few years ago, the funds I manage had 10 percent of assets in China. Today we have a similar amount in South Korea and Taiwan, including Samsung and Taiwan Semiconductorswhich are the most important stocks in each index.
We also have broader exposure to emerging markets through holdings in developed countries. Take as an example, singapore telecommunications, which has a majority stake in the largest mobile operators in Indonesia and Malaysia. This is a good example of the businesses we particularly like: resilient businesses operating in “cockroach” industries from what we think of as safe homes.
Investors can’t avoid risk, but there are often ways to help mitigate it.
Simon Edelsten is co-manager of Mid Wynd International Investment Trust and Artemis Global Select Fund.