Investors are not crediting companies in China for growth they have already delivered, according to Investec Asset Management’s Sahil Mahtani, meaning this market could surprise to the upside in the coming years.
And Mahtani, a strategist at Investec’s Investment Institute, said China’s vast rural population could hold the key to this outperformance.
Many investors remain sceptical towards investing in China, with slowing GDP growth leading to concerns it could follow the pattern of boom and bust seen in Japan in the early 1990s. However, Mahtani, a strategist at Investec’s Investment Institute, said there are two reasons why this is wide of the mark.
“One, China has 560 million people in rural areas, which means it has the urbanisation profile of Japan in the 1960s, not the 1990s,” he explained.
China's rural population
Source: Investec Investment Institute
“And the second is, if you look at the capital stock per capita of China, it’s actually less than half what you find in Japan and South Korea.
“This suggests that while there are clearly some aspects of over-investment in China, it is geographically concentrated in coastal areas. Whereas if you look at a huge part of the interior in China, there is relative under-investment.”
Mahtani said the potential in China’s rural population is misunderstood by investors and analysts, even those who are based in the country. In a recent collaboration with SOAS University of London, the Investec Investment Institute examined the enormous amount of investment into telecoms, transport and broadband in rural China over the last 10 years, which has led to an e-commerce boom in this part of the country.
However, this development seems to have flown under the radar of the investment community.
“In Alibaba’s latest results, it said that ecommerce in rural China is growing at 30 per cent a year, whereas in the rest of China it is growing at 24 per cent a year,” Mahtani continued.
“And just to show you now where China is, if you look at the implied growth rate, according to some models for what Alibaba is going to do over the next few years, it’s 11 per cent. And yet e-commerce in China, in which Alibaba is dominant, is growing at closer to 25 per cent.
“It just shows you investors are not really giving many Chinese companies the credit for the growth that they are already achieving in the here and now.”
Mahtani said the key to understanding the opportunities in rural China is understanding the workings of the Chinese government. For example, it has a political meritocracy, which is sometimes referred to as a “political tournament”, whereby certain measurable outputs are used to determine which officials are promoted.
E-commerce growth potential in rural China
Source: Investec Investment Institute
The strategist said an important recent development has been a change in measurement metrics away from pure GDP targets and towards those that require a focus on equality, environmental damage, and so on.
“And rural China now has a specific new component in some of the measurements that some of these officials are subject to,” he added.
“So that tells us that the policy change is durable. The e-commerce shift is clearly durable because there’s a virtuous cycle between people becoming e-commerce store owners, gaining more prosperity and becoming consumers who are buying more products.”
One of the biggest threats cited to major tech companies in the West is the state, with some fund managers fearing government interference in the form of taxes, fines and regulation.
However, Mahtani said that as disruption appears to be accelerating rather than slowing down, there may be a change of attitude, with the state leveraging the power of tech giants rather than fighting a losing battle – something that is already taking place in China.
“You’ve seen this with Alibaba in rural areas where it is effectively becoming an arm of the state. The state funds warehouses, funds its operations, and it is actually quite a capital-light model considering how much PPE [public-private enterprise] it has.
“And you are already seeing this discussion in the US, when Mark Zuckerberg got on stage and said, 'you really should support Facebook’s Libra digital currency, because the real threat is not Libra, but what comes outside the United States'.
“So I think the interaction between technology and society will be a key trend over the next decade,” he finished.