Causeway Capital Commentary: R – GuruFocus.com
We believe the sensational elements of recent regulatory reform (sudden announcements and in-depth reviews) distort the underlying reality of China’s regulatory progress. Overall, we consider these policies to be reasonable and long overdue. The Chinese government implements consumer, labor and environmental protections that are long-standing components of many developed economies. His concerns about antitrust and data privacy in the tech industry are shared by policymakers in the US and Europe, albeit expressed more unilaterally. Historically, one of the challenges of investing in China has been the low levels of regulation between sectors and the variability in how companies have complied with regulations. We believe that well-established, consistent and transparent regulations should ultimately reduce the risk of investing in China. We also believe the opposite: if regulations are arbitrary, or if opaque regulations proliferate, then investment risks increase. Importantly, we do not currently believe that the recent Chinese regulations are aimed at driving out foreign capital.
Where could regulators turn next?
Investors need to identify the motivation for regulation. We recognize five regulatory themes:
1. Regulations to support China’s long-term government policies: Based on previous communications from Beijing regarding the government’s long-term goals, we expect regulations designed to promote population growth and common prosperity / social welfare. We also expect the government to mitigate systemic risks in the financial system.
a.) We believe that there are three main burdens on the Chinese family today: education, housing and health care. Following draconian restrictions on for-profit educational businesses, we expect future regulations to focus on housing and healthcare.
b.) Possible targets for systemic risk mitigation include management of pensions and social security accounts, bank and non-bank loans, and consumer credit.
2. Increased protection of consumers, labor and the environment:
a.) Consumer: increased monitoring of the quality of consumer products and predatory practices hidden in consumer credit. Strict limits on video game time for minors can reduce addictions as these young people age and increase productivity.
b.) Labor: Reform in all industries focused on employer-paid benefits. For example, food delivery and express delivery companies may need to start offering benefits to drivers.
c.) Environment: control of heavy pollutants and implementation of carbon quotas.
3. Anti-competitive / strong targeting> China introduced antitrust regulation in 2008, but Xi Jinping’s government has stepped up its implementation. Dominant / monopolistic players in industries that directly affect consumers remain particularly vulnerable.
4. Data ownership / data security: The government considers user payment data to be essential public goods, but currently lacks the technological resources and capacity to store and analyze the data. We expect regulations to support the transfer of highly sensitive user data from private to public hands.
5. US / China competition: We could see more policies favoring local substitution and promoting research and development led by China.
We study all of these areas, focusing on those that present the most ambiguity. As fundamental analysts, our risk analysis is primarily conducted at the company and industry level, where we seek to identify companies with compelling value propositions that can realize their profits through fair competition. We consider a sole proprietorship within the framework of these regulatory themes. We seek to avoid companies that we believe have inflated growth and profit margins due to what regulators qualify as abusive treatment, such as excessive working hours and poor working conditions. These companies may face headwinds related to rising labor and manufacturing costs and other effects of these regulatory goals.
We expect both winners and losers as regulation progresses. It is important to recognize that some companies, especially scale players, should benefit from increased regulation. For example, stricter carbon emissions standards can drive consolidation in the manufacturing sector and provide benefits to industry leaders. Some delivery companies already offer social benefits to their drivers and will benefit when lagging companies have to absorb further cost increases.
Does negative sentiment present buying opportunities?
Beijing’s recent regulatory crackdown has taken a heavy toll on the stock prices of major Chinese tech companies with well-capitalized and valuable platforms. We believe that some Chinese Internet stocks may anticipate an overly pessimistic future. For our Global value, International value, and dedicated China portfolios, we are currently researching several high quality Chinese technology franchises that we believe may have been sold and traded below their intrinsic value. We believe these franchises should adapt and then prosper. Investments by Chinese tech giants in areas such as artificial intelligence, autonomous driving and buying community groups have the potential to generate significant returns for shareholders. We believe this may be a good time to take advantage of investor pessimism and low stock prices.
Pavement Global and International Value portfolios currently hold two stocks with predominantly Chinese economic exposure. We believe these companies are relatively insulated from unforeseen Chinese regulatory risks. One of them operates in the casino industry in Macau, providing lucrative business, jobs and tax revenue to the Chinese economy. Another is an airport holding company serving the Chinese domestic market. Like the others Inventories impacted by the Covid in Causeway’s client portfolios, we expect profitability to pick up again as travel and leisure activities normalize after the pandemic.
In the Causeway Emerging Markets and International opportunities strategies, China is the largest weight in emerging market countries, although the portfolio’s exposures are currently below benchmark. For these strategies, Causeway quantitatively selects emerging market equities with a fundamental risk overlay. Regulatory risks often fall outside the scope of quantitative models, which is why our China Research Department helps our quantitative colleagues assess the risks to Chinese holdings. The largest overweight positions are concentrated in sectors outside the current regulatory reticule. We maintain exposure to some of China’s largest internet stocks, due to their value, growth and momentum characteristics and our constraints relative to the benchmark.
What about the risk of US and Chinese government restrictions on foreign investment in Chinese companies, especially those listed on the stock exchange?
Nearly 250 U.S. certificates of deposit (ADR) from Chinese companies are listed on three U.S. stock exchanges using “variable interest entities” (VIEs). As tensions between the United States and China escalate, these listings appear increasingly vulnerable to regulatory action, including mandatory delisting, from both governments. There are also concerns that the US government is restricting investments by its citizens in the shares of Chinese companies listed in Hong Kong (H shares). We believe that a full financial decoupling of the United States and China is unlikely, as it does not benefit either party. We take these risks into consideration when accessing Chinese companies on behalf of our clients through a combination of Hong Kong, US (ADR) and Mainland China securities.
Final thoughts to share with our clients?
Economic development is the cornerstone of social stability in China, and we believe that China’s economic modernization will continuously provide investment opportunities. Despite recent shocking regulatory measures, we believe that China’s domestic policy goals are framed around pragmatic political and economic goals and include the continued opening of its capital markets. The opacity and inconsistency of regulatory measures would likely weigh heavily on investors’ perceptions of the risk of investing in China. We also need to assess the balance of power between private sector leaders and the Chinese Communist Party, as increasing state ownership would likely erode national prosperity. We have staffed our research office in Shanghai to bring us closer to businesses, industries and the very important regulatory framework. Opportunities for long-term equity investors in China may ultimately outweigh regulatory risks if controlled by diligent research and in-depth risk analysis.
This market commentary expresses Causeway’s point of view as of September 2021 and should not be construed as research or investment advice regarding any stock. These views as well as the holdings and characteristics of the portfolio are subject to change. There is no guarantee that the forecasts made will come true. Forecasts are subject to many assumptions, risks and uncertainties, which change over time, and Causeway assumes no obligation to update these forecasts. The information and data presented have been developed internally and / or obtained from sources considered reliable; However, Causeway does not guarantee the accuracy, adequacy or completeness of this information.
International investment may involve a risk of capital loss due to adverse fluctuations in the value of currencies, differences in generally accepted accounting principles, or economic or political instability in other countries.
 China-US Economic and Security Review Commission, May 2021