Deep Dive: Endowus China Equities Portfolio

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The article was first published in 2021 at the launch of Endowus Satellite Portfolios and was updated on 21 November 2024, following recommended portfolio changes to Endowus Satellite Portfolio - China Equities. The RPC is part of Endowus’ commitment to source funds that will optimise your portfolios.  Find out more about the portfolio enhancements.

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What is the Endowus China Equities Portfolio?‍

The Endowus Satellite Portfolio - China Equities is designed to achieve long-term capital appreciation by providing exposure to China’s structural growth opportunities via allocations to A-shares, H-shares and US-listed ADRs, with a focus on A-shares.  

The Portfolio is intended for investors who seek significant alpha opportunities and are looking to invest in a diversified and efficient China equity portfolio for the long term.

Read more: The alphabet soup of China equity markets

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The latest recommended portfolio change aims to help the portfolio better meet its objective. This is achieved by broadening the portfolio’s exposure to structural growth opportunities by increasing allocation to the onshore market and enhancing portfolio resiliency across market cycles by improving style diversification and optimising manager selection.

What are the underlying funds in the portfolio?

We have selected five best-in-class funds focused on investing in China and related regions and companies, managed by globally-renowned fund houses who are experts in investing in China and Greater China markets including BlackRock, Fidelity, JP Morgan Asset Management, T. Rowe Price, and UBS Asset Management.

The funds were chosen for their strong, market-beating performances that place them among the top percentiles among their peers, as well as for their unique investment focus as summarised above. Collectively, the funds provide investors an optimised exposure to investing in China.

Why invest in China stocks?

China's market outlook remains strong despite regulatory risks

China has rapidly emerged through unprecedented growth and thereby transformed itself into the second largest economy in the world in a short span of time. Despite this, there have been looming concerns on the sustainability of China’s high growth rates and concerns about structural issues that have been paved over and will come back to haunt them. The huge indebtedness of and debt-fuelled growth is a major concern especially in certain sectors of the economy including real estate and manufacturing. These concerns have been exacerbated by the regulatory risk and systematic risk of being a control economy. With the recent regulatory crackdown casting major doubt about some of the most prominent companies in the Chinese equity market.

However, not all sectors are heavily and negatively impacted by the crackdown, and investors should consider a more diverse universe outside of just high-profile names and shows why diversification is so critical even within a China market universe.

Additionally, given that such anti-monopolistic market intervention is rather common and well-received by both large and small players in sophisticated economies like the US and Europe, a more prudent investor might view regulatory risks as a necessary growing pain as the Chinese economy matures.

Regulatory risk is not something new to the Chinese market — recall events such as the US-China tensions in 2018, and the market crash in 2015 that followed after the opening up of the Onshore stock market. Despite such headwinds, the market has demonstrated some resilience through these unique challenges and in the end as a growth asset class, equities returns will be determined by the earnings growth of the listed entities in the stock market.

China offers a large, diverse investment universe

In that regard, despite the complicated structure of multiple stock exchanges and multiple listings of certain companies, this provides a broad opportunity set from which to invest and generate investment returns.

The Chinese equity markets have both the onshore exchanges (e.g. Shanghai and Shenzhen Stock Exchanges) as well as offshore markets (e.g. Hong Kong) and we have invested in funds that have investments in a broader mandate of companies with high China exposure as well.

This exposure to not only the second largest equity market in the world, but also more broadly companies that leverage the second largest economy and consumers carry rather distinct opportunities that are diversified.

Another characteristic that makes Chinese equities unique is the fact that its economy is heavily driven by domestic factors. Companies on the onshore Chinese market derive, on average, 90% of their revenue locally, which reduces the economy’s dependence on global macroeconomic trends. Companies in the region, such as Hong Kong and Taiwan, are similarly reliant on mainland Chinese revenue rather than from the rest of the world.

This is really important when we look at China equities in comparison to other major markets in the region and globally. It is interesting to note the very low correlation China markets have with other global markets. This is another attractive point for investors who want to add further diversification benefits or uncorrelated returns to their investment portfolio.

China offers significant alpha opportunities

Experienced investors would remember that the onshore Chinese market used to be largely inaccessible to foreign capital. The onshore markets opened up partially to foreign investors only in 2014 via the Stock Connect Programme, and prior to that, the Hong Kong stock exchange provided an alternative for foreign investors to gain exposure to the Chinese market.

It is exactly due to this “infancy” of the onshore Chinese market, however, that it offers attractive alpha opportunities for savvy investors. As the market is new to the broader investor base and therefore under-analysed, it rewards investors who put in the effort to understand the companies in greater detail and allocate to those with sustainable long-term fundamentals.

Additionally, the Chinese equity market is currently trading at a valuation that is lower than other major global markets. While this is partially due to the regulatory and systemic risk and the fact that capital markets are not completely open to foreign investors, there are certain companies or sectors that naturally present opportunities for re-rating over time as the market continues to open up and the companies deliver higher growth.

Who should invest in China stocks?

While Chinese equities offer highly attractive opportunities as outlined above, the market is not without its risks; in fact, the market is a highly volatile market with high retail participation and low institutionalisation. Therefore, an investor should consider his risk appetite carefully before deciding to allocate specifically into China.

A quick and simple assessment of one's risk appetite with regard to investing in China would be for an investor to ask themselves: If the Global Financial Crisis (GFC), US-China Trade War, or regulatory crackdowns were to happen again tomorrow, will I be able to stay invested despite the short-term losses?

In the three market crises in 2007 (GFC), 2018 (US-China trade war), and 2021 (regulatory crackdown), the MSCI Golden Dragon Index, a broad index of Greater China large and mid cap stocks, suffered large drawdowns of approximately 60%, 13%, and 16% respectively. Although such events may have been rather unusual and infrequent, there is no guarantee that something of a similar nature will not occur again.

Additionally, apart from such major market crashes, the Chinese equity market has been historically volatile with an annualised volatility of 21% from May 2000 to October 2021. Given this, another relevant question for investors to ask themselves would be: How long can I stay invested with the losses, if there was even a small dip in the Chinese equity market tomorrow?

Ultimately, the longer one’s investment horizon, the greater the chance of the investment riding out the market volatility to achieve a higher return.

All in all, investors who are prepared to withstand the potentially steep losses arising from market volatility and have a mid-to-long-term investment horizon would be best suited to allocate to Chinese equities.

Why should you invest in the Endowus China Equities Portfolio?

Invest in a diversified and efficient portfolio

A country portfolio has limited ability to diversify, but the China market is unique in that it has several stock exchanges in different jurisdictions with a diverse range of sectors being represented in these various exchanges.

The overall diversification of the portfolio is also achieved through a purposeful determination in the portfolio creation to make it a Greater China portfolio where the opportunities to invest in both onshore and offshore markets allow a slightly broader investment opportunity through diversification to other geographies like Hong Kong, Taiwan, and Macau, and also through various currency diversification in HKD, TWD, USD, and more.

This is especially true when assessing the portfolio from a sectoral point of view (as previously shown), as well as based on the place of listing.

Additionally, the portfolio will tactically allocate into the onshore or offshore versions of the underlying equities when considering Chinese companies that are dual-listed — this is efficient because there are occasions when the onshore versions trade at a higher price, due to the immaturity of the onshore market that attracts high participation from retail investors and there are arbitrage opportunities.

Active management by top fund managers to generate higher returns with lower risk

Given the vast investment universe for Chinese equities, as well as the complexity in obtaining local, ground-level knowledge that impacts the day-to-day operations of the companies, we think that Chinese equities investing can be most efficiently done by leveraging the expertise of expert fund managers to extract alpha through their unique investment approaches. This is also especially true when looking at onshore Chinese equities, as the market is less mature and provides attractive alpha opportunities.

The portfolio has been constructed to benefit from the collective wisdom of the underlying funds to generate the best possible risk-adjusted returns through exposure to a diverse basket of companies across Chinese equities, and this has proven to be successful historically compared to the market.

China is unique in that there is no single market index that represents the broad market well. Due to the narrow scope of some of its various indices it is even difficult to track what the overall Chinese market has done.

The table below shows the four major indices that people use to track the China market overseas, with the MSCI Golden Dragon being the broader measure including the Taiwan and Hong Kong markets. Across the various indices, the Endowus China Equities portfolio has generated good returns adjusted for risk and represents the opportunity to expose yourself to the broader Greater China markets.

Ongoing assessment of underlying funds by the Endowus Investment Office

The underlying funds in the portfolio have been selected based on the rigorous assessment by the Endowus Investment Office for their superior quantitative and qualitative characteristics, and are believed to be the best-in-class among their peers that are available to retail investors in Singapore today.

However, with that said, we recognise that the China equity market is constantly evolving, giving rise to new ideas and funds that effectively capture them. To make sure that the portfolio reflects the best opportunities in Chinese equities investing, we conduct ongoing re-assessments of the funds to ensure that their superior characteristics are maintained into the future, and where needed, to introduce new funds to supplement or replace the existing portfolio design.

‍Learn more: How you should approach a core-satellite portfolio investment strategy