What you need to know on China equities and Evergrande

The Evergrande saga

The Evergrande story escalated in the middle part of September as scenes of disgruntled investors protesting at Evergrande’s headquarters in Shenzhen emerged. This was a sign of the group’s struggles as Moody's downgraded Evergrande’s issuer rating to Ca, and its senior unsecured bond rating to C, which is considered the lowest level in the rating mechanism. Fitch also followed with another downgrade the next day and pointed out that they think "a default of some kind appears probable."

As covered in the iFAST Fixed Income Research Team’s article published on 16 Sep 2021 - Evergrande's woes deepen, one of the important indicators investors had to look out for, was whether Evergrande would be able to make its bond payment of approximately 83.5 million USD in the following week.

In a further sign that things were not going well, Evergrande did indeed miss its bond coupon payment for its “EVERRE 8.250% 23MAR2022 CORP (USD)” that was due on the 23 of September. This update was covered once again by our Fixed Income Research Team’s in follow-up article published on FSMOne.com: “Evergrande’s crisis and where is it going”,

In the most likely scenario, we expect Evergrande’s debt to be restructured in an orderly manner, with healthy developers asked to take over Evergrande’s unfinished projects in exchange for a share of the distressed developer’s land bank.

We also expect that the Chinese government, which recoqnises the important of real estate as a strategic sector to take advantage of the highly-regulated nature of the China property sector and employ its numerous policy tools to stimulate the sector, which should allay fears about broader contagion within the sector.

Global Contagion?
As this story unfolds, investors might be tempted to compare the troubles in China’s Real Estate sector to the 2008 global financial crisis, which stemmed from a property crisis. With Evergrande’s sheer market size as well as the amount of debt it owes to many financial institutions, global investors’ worries that the company’s default may impact China’s already weakening economic growth, and could eventually weigh on global growth. Market sentiment in late September began to wane globally, as some feared the effects of contagion this might send through the system.

However, at FSMOne.com, we believe that Evergrande is unlikely to be China’s Lehman Brothers moment, and that contagion fears are significantly overblown. In this article, our Unit Trust research analyst elaborated on key reasons to explain why Chinese authorities will be trying to prevent a full-blown contagion, before examining the impact the Evergrande saga had on fixed income funds (and in particular Asian High Yield and Asian bond funds) and equity funds.

As the situation is expected to remain fluid, and uncertainties may continue to bring about market volatility in the near term, our Research Team has urged investors to stay calm and acknowledge the noise, but focus on the big picture and on the long-term. Investors should note that the property sector constitutes a 2% weight in the MSCI China A benchmarks, and 3% in the MSCI All China index – a small part of China’s equity market. Consequently, investors who hold China equity funds are unlikely to have any meaningful exposure to Evergrande, given its small weight in the market benchmarks.

What next for Chinese real estate and companies with Chinese real estate exposure?
As Evergrande’s struggles intensify, the Chinese Real Estate sector finds itself in the crosshairs. Our Stocks & ETFs Research team has published an article “As the Evergrande crisis deepens, what's next for the Chinese real estate sector?”, which highlighted some key trends that investors should look out for, especially with the increased regulatory requirements recently imposed by the Chinese authorities.

Investors who are wondering how to approach this sector with fears of Evergrande’s contagion, may also read about our analyst’s take of the three possible scenarios on how Evergrande could impact the entire real estate sector.

With news of Evergrande’s struggling, the impact has also reached areas of the market connected to the Chinese real estate sector, and investors were also concerned with companies that had exposure to the Chinese real estate sector. Ping An Insurance, who was unfortunately one of the top shareholders of indebted real estate developer China Fortune Land was not spared in the recent market selloff, with its share price falling by another -30% since our Stocks & ETFs research team’s last update. With Ping An having disclosed that the company does not hold any Evergrande’s equity or debt, our Stocks & ETFs research team has written an update “After the fall of China Fortune Land and Evergrande, and what’s next for Ping An Insurance?” to examine concerns over the company’s real estate exposure, and if the company still provides any opportunities for investors. 

Chinese Technology

Although not as much in the news cycle as before, China’s crackdown on technology stocks has left the Hang Seng Tech Index as of 22^nd September 2021, at about 40% off its highs in February this year, as the sector reacted to the impact of a series of regulations passed by the Chinese government.

How should investors understand the situation and are there any diamonds in the rough that can be acquired? Here are two articles penned by our Stocks & ETFs Research teams that will be helpful:

1.       Long-term growth intact despite China’s Big Tech crackdown

2.       JD.com: A potential winner amidst China’s Big Tech crackdown

Essentially we believe that the fears are overblown and we remain positive on the China tech sector due to the long-term growth story of the sector remaining intact amidst growth catalysts such as rising internet penetration rates and the digitalization of consumption. We are also of the view that the regulations imposed by the government are not intended to hamper the growth of tech companies, but rather to safeguard consumer interests, ensure sustainable growth of the sector and maintain social stability.  

At its current valuations, the Chinese technology sector is looking attractive. Investors can use this opportunity to gain exposure via the iShares Hang Seng TECH ETF (HKEX:3067). Accounting for a lowered fair PE ratio in lieu of the heightened regulatory risk, the 2023 target price for this ETF is HKD 19.40, which translates to an upside potential of approximately 50% (based on the last closing price on 29 September 2021).

Common Prosperity – Ride the Tailwinds

All in all, we encourage investors exposed to China to acknowledge the noise, but focus on the big picture. In this in-depth article, we connect the dots behind the headlines to understand the situation in China and provide a suggestion as to how investors can position themselves to take advantage of the long-term growth story -  China’s Common Prosperity – What does that mean for investors?

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Finally, at FSMOne.com, our aim is to help our clients invest globally and profitably, through our effective coverage of investment opportunities as well as the products and services we offer. In this period, seize this opportunity together with FSMOne.com – with our Limited Time Promotion, where you can enjoy Free Trades and Bonus Units when you invest in these funds and sectors which our research analysts have highlighted for having the potential to benefit your portfolio.

Watch - The Evergrande Crisis And What It Means For Investors