Counter volatility in China with a relative value approach

China has clearly shifted to prioritizing economic growth in 2023. Significant policy changes, most notably the full relaxation of COVID restrictions late last year, fueled a strong beta-driven rally after a turbulent couple of years for Chinese equity markets. Commitment to expanding domestic consumption and supporting a broad-based recovery was reiterated with care at the recent National People’s Congress (NPC).

While there are early signs that point to momentum in the nascent rebound, a robust economic recovery is not a foregone conclusion amid rising China-US geopolitical tensions and recession risks in developed markets. In fact, our on-the-ground research indicates that a weaker-than-expected recovery could be a possible outcome, and the beta rally could be coming to an end.

We are constructive on China and view the macroeconomic backdrop as largely favorable for the long run. However, we believe that investors still need a way to capture long-term alpha opportunities, as well as a directional beta-driven approach, to successfully navigate evolving market dynamics.

In a choppy market, a low net, relative value approach on both the long and the short sides could provide a differentiated source of returns. The so-called all-weather solution is designed to deliver attractive risk-adjusted returns through varied and often difficult market conditions. We are not only agnostic to the direction of the markets, but we aim to be uncorrelated to the broad Chinese equity and bond indexes.

It is important to note that a relative value strategy is not structured to outperform long-only strategies in a bull market. That said, adding a long/short approach to a long-biased portfolio, whether passive or active, could make a good complement and help improve overall returns while lowering portfolio volatility. The reasonable use of leverage and the flexibility to hold non-China exposure to take advantage of different economic cycles can also add value.

China set key economic objectives for 2023 at the NPC, including the much talked about GDP growth target, which are modest and relatively conservative. We believe that policymakers regard the proposed growth-supporting measures as more of a put option – meaning they would have the option to implement them should conditions require so. In our view, and in line with market expectations, a more aggressive set of stimulus package similar in size and scale to 2009 or 2019 is unlikely, given the long-term impact it would have on the economy.

A key reason is that the Chinese economy is going through a transition. After growth periods previously driven by exports and then by real estate investments, China is entering a next phase of growth where advanced manufacturing industries could play a crucial role. The push for technology self-reliance and higher competitiveness may translate to opportunities in artificial intelligence, electric vehicles, solar power, robotics, automation and semiconductor equipment. There is also exciting potential tied to decarbonization in green power, materials and commodities.

This growth transition will bring many fundamental changes, and because some of the approaches are unique to Chinese ideology, they could be misunderstood by those outside of China. Striking a balance between eastern and western thinking is not easy, but our onshore presence coupled with a strong primary research process allow us to have such integrated insights. Moreover, more specific details from the upcoming state council meetings and the politburo meeting in April should give us more information to assess the new policies and the support for the transition.

 There appears to be a long runway for structural alpha opportunities in China on the back of both the market and macro development that is supportive of its economic growth and transition. In the short term, there are still some uncertainties around the strength of the recovery that may result in persistent volatility. We believe that complementing a directional beta-dependent allocation to China with a strategy that has a low net long/short approach still stands as an effective way to achieve attractive risk-adjusted returns over the long term.