C H I N A’ S M A R K E T O U T L O O K
However, it is tough to forecast a sustainably higher median IRR vs. global peers, given that policymakers are seeking to rebalance efficiency and equality in the economy, and because China’s PE/ VC-backed companies compete with state-backed entities. Chinafocused PE/VC should nonetheless continue to be appealing to foreign investors to deploy accumulated dry powder. We expect China’s private markets to continue beating public ones, for venture capital to remain the dominant strategy and for the pool of managers to improve in quality.
The renminbi The RMB should appreciate during our forecast horizon as a result of ongoing efforts to improve its convertibility; higher foreign investor inflows; China’s likely continuing growth advantage vs. developed markets; and the RMB’s undervaluation on a purchasing power parity (PPP) basis. As the RMB becomes more freely convertible and widely used, it should converge toward its fair PPP value. We forecast an equilibrium USD/CNY level of 5.29, implying an annual appreciation of 1.6% vs. the USD.
Throughout, manager selection should remain a key variable: As China’s economic growth rate likely continues a structural decline, investors will need to apply management know-how to the capital deployed and focus on those new economy sectors that enjoy policy support.
HOW DO THESE STRUCTURAL CHANGES IMPACT OUR CHINESE MARKET VOLATILITY ASSUMPTIONS?
Real estate
Equities
China real estate returns data is spotty and varies significantly by sector and location. We think the days of double-digit returns in residential and commercial real estate are over, with returns already on a downward trend over the past five years compared with the previous five. Looking forward, as certain areas of commercial real estate aligned with FYP priorities receive more support, they should deliver better returns relative to other sectors, through both higher yields and their potential for moderate capital appreciation.
We expect onshore equities’ high volatility to fall over the next 10 to 15 years as institutional investors’ share of total holdings and volume gradually increases. A shares’ volatility should approach that of other major EM equity markets toward the end of our forecast horizon, with the potential for policy-induced volatility along the way.
Residential for-sale properties will likely continue to face regulatory scrutiny. On the other hand, private sector residential rental housing and the multi-family sector may benefit, as the Chinese government is expected to continue with policies to bolster affordable housing for lower income citizens and those migrating into new cities seeking job opportunities. Senior care housing will be on the receiving end of policies to meet the demands of China’s aging urban population. These areas of development are still early-stage but worth watching in the long run. REITs in China currently have an average yield of 6.1% (ranging from 4.2% to 11.5%)14 – a bit higher than other Asian markets. As China’s REITs market develops, the average yield should decrease as the sector mix shifts away from higher yielding sectors and public sponsors. Returns may also be boosted by capital appreciation and rerating if properties are efficiently run.
14
Bloomberg, as of July 31, 2021.
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Fixed income CGBs’ volatility, currently lower than other EM government bonds (EXHIBIT 5), could pick up slightly, to levels comparable with major developed market government bonds. We expect this outcome as an interest rate-led monetary policy framework ramps up, and also due to more active trading by asset managers on- and offshore.
RMB The RMB’s volatility is currently lower than most EM currencies’; this differential is likely to narrow as a more flexible FX regime evolves. But we believe the RMB’s lower volatility than other EM currencies vs. the U.S. dollar, and vs. a basket of trading partner currencies, is likely to persist, as China’s capital account liberalization is likely to be a gradual process. For investors with the flexibility, an unhedged allocation to China is worth considering, given our forecast for RMB appreciation in the coming years.