Sentiment towards Chinese equities has gone from hot to cold and seemingly back to hot again in recent weeks. To make sense of this. I'm joined today by Allison Fisch, Managing Principal, President and Portfolio Manager at Pzena. Founded in 1995, Pzena are a deep value equities boutique based in New York City. They run 50% of the Vanguard Global Emerging Markets Fund alongside growth manager Baillie Gifford.
Allison, perhaps you could start by walking through what the trigger was for this change in market sentiment towards China?
Yes. So the government announced a number of stimulus measures, really aiming at kickstarting the economy and getting things moving in the right direction. A lot of the measures focused on the housing market, which has really been at the heart of the crisis here.
So it's things like, reducing the down payment requirement for second home mortgages, direct mortgage relief on rates. some measures that, that are encouraging banks to buy some of these troubled properties. And also measures aimed directly at increasing consumption, all the way to the level of direct handouts to poor people. Details around that still yet to be sketched out.
But at any rate, the market had really been waiting for some help from the government that had been a long time in coming. And so there was a very quick, and very strong reaction to this announcement. You saw markets moving up, something like 25% just in the first five days after the announcements.
And, you're a deep value manager. You've described your process in the past in China as finding gems amongst the wreckage. Does that still apply? And what does news like these sort of policy announcements do for your process and for the companies you're looking at?
Yes. So every company that we own, we've bought because it's a good quality business going through some sort of temporary pain, which may be due to the economic environment, may also be self-inflicted.
So certainly if that environment is going to improve, that will give some relief to those businesses. But we didn't invest in any of the companies we own in China based on any sort of timing expectation around improvement. Really, what we're investing in is looking for quality businesses that are very, very cheap. And what's happened over the last few years is China has gotten very, very cheap.
So as we've seen valuations of the Chinese market come down and down and down over the last several years, our weight in China has gone up and up and up because business by business, we've been able to add so many quality franchises to our portfolio, just at cheaper and cheaper prices. So when you see moves like what's happened over the last few weeks, what does that do to our portfolio?
Well, a lot of these Chinese businesses that we own have now become relatively more expensive than they were. The bulk of them, however, are still extremely cheap and still deserve a spot in the portfolio. They've just gone from being sort of the cheapest of the cheap to looking more like what we think the cheap part of the portfolio should look like.
For us, we hunt in the cheapest quintile of cheap companies when we're looking for names to add to our portfolios. And what we've found over the last few years is something like 40% of that first quintile was Chinese businesses. That's pretty extreme. That's the most that we've ever seen. So with this move in this, sort of outsized move in the Chinese markets versus other markets over the last few weeks, that first quintile is starting to look a bit more balanced.
And we've been talking about the Chinese market as if it's a singular entity. It's clearly not. It is unique in emerging markets for its diversity and breadth. Perhaps you could break that down and give us some examples of the sort of companies you're finding.
Thank you for bringing that up. I think sometimes we do get caught up thinking about entire countries as one thing.
But that's actually what's particularly exciting about the Chinese markets is that they are so diverse, within just the the index, you have over 600 companies in China, and they cover something like 80% of the various industries, that can be represented within the index, for emerging markets. So there's tremendous breadth in terms of the different kinds of business models and the different kinds of controversies, that you can therefore invest into.
You contrast that with a country like India, where in terms of the market weighting, it's not that different. But within India you're only looking at, a few hundred companies. So much more opportunity if you're looking for company specific, really interesting controversies, in China.
And let's get onto that comparison between those other major EM markets. So, you've walked through China; Brazil, you’re underweight and you've got very large underweight to India. So what are the fundamental differences there other than the number of companies available to you?
For us it really comes down to valuation. If the expectations around a country are very negative and the valuation is very cheap, then we're likely to get involved there.
It’s not as if we have a view that people are wrong about India, where as you mentioned, we're very underweight. The macro does look quite encouraging there. The demographics are much more appealing there. But that's already priced in. So if we roll down the road a bit and things work out really great in India, then okay, you got what you paid for because you're paying a really high valuation today for that future stream of earnings.
But if there's any sort of disappointment or any hiccup along the way, then you're going to have a problem. A place like China over the last few years has gotten so cheap, it's priced for things to be absolutely terrible. And that's why markets react the way they did over the last few weeks, that when there is now a hope of some relief coming, that reaction to to the positive becomes very extreme in a market that's been so sold off.
Allison, thank you very much for your insights. Thank you.
All views as at 8th October 2024.