Well, China just squashed a big one. Ant Group, the world’s largest FinTech company, was set to become the largest initial public offering (IPO), until Chinese Regulators suddenly pulled the plug with little explanation. China, home of one of the largest economies in the world, makes Chinese stocks an increasingly necessary inclusion in portfolios, despite the erratic risks that might come with them, as exemplified last week. Off the heels of this news, Chinese internet giants are also sliding due to proposed regulations that hit the technology sector.
While performance of late has been less than desirable, we are not calling an exterminator yet.
As investors, it is becoming more difficult to exclude Chinese stocks from portfolios, but it is important to keep in mind the idiosyncratic risks involved. Political risk is a major factor in any “emerging” market like China, which can increase uncertainty and volatility. The Chinese government is vastly intertwined in its financial markets, allowing sudden unforeseen regulations to affect companies and their investors. Like with Ant, Chinese regulators have the upper hand in influencing financial markets, rather than letting them trade freely like the rest of the world.
The political risk in China extends further than blocking IPOs. Alibaba, the mega tech giant, has also recently faced some hurdles with the Chinese government. Just this past week, China released antitrust guidelines that would lower the barriers to entry and even the playing field of its e-commerce giants. The news has placed some downward pressure on some major Chinese tech stocks in fears that the companies’ earnings growth will be artificially suppressed. State officials are even going so far as requiring some companies to hold reserves, akin to big banks. Worrisome? Unusual? Both?! This isn’t the first time we’ve seen China step in with regulations and it certainly will not be the last.
However, as with any investment, it is important to understand all risks involved. There is a general rule of thumb that the greater the risk, the greater the potential return. In other words, if I am taking on more risk by investing in a Chinese Tech Giant, versus a similar, US based company, I should be potentially compensated for that. So, while risk can be good, and can be bad, it is important to understand all risks and what role International and Emerging market stocks can play in terms of diversification and growth. To illustrate this point, let’s look at the returns of a few companies. As of the end of October 2020, Alibaba and Tencent saw an annualized total return of 29.5% and 32.6%, respectively over the last five years, beating some domestic large tech companies, such as Facebook (20.9%) and Google (17.0%).
Inclusion of Chinese companies’ stock in more portfolios helps outside investors with potentially higher returns and diversification, and domestic Chinese investors with inflows of capital, but someone should tell the Chinese government, you can step on one ant, but you cannot crush them all.