Prevailing Winds is a China-focused blog written by Nicholas Borst, Director of China Research at Seafarer. The blog tracks the economic and financial developments shaping the world’s largest emerging market.
Investors in China must be prepared to grapple with the nuanced complexities of state control in China and its impact on companies, both state-owned and private. State control of companies in China is not as simple as ownership: private companies in China may fiercely pursue their own interests in some areas while acquiescing to government priorities in others. Investors only looking at a company’s ownership structure may miss the shifts in Chinese government policy that will shape the future of the business and its industry.
I address this topic in a commentary titled State-owned Enterprises and Investing in China. Below is an excerpt from the commentary.
In the minds of many investors, Chinese state-owned enterprises (SOEs) conjure up images of moribund and bloated companies that are run for policy objectives and not profits. It’s true that state-owned enterprises are less efficient than private firms in China. For example, across the industrial sector, state firms have a return on assets (ROA) less than half that of private firms and the gap between the two appears to be growing.1 Over the past few years, Chinese authorities have enacted a range of policies to improve the performance of SOEs, including corporatization, industry consolidation and the introduction of outside capital. Unfortunately, these policies have mostly been failures and state-owned enterprises are a significant drag on China’s economic growth.
The performance gap between state-owned and private enterprises persists for publicly listed companies. By one estimate, listed private enterprises outperform state-owned enterprises by a factor of 2:1.2 Given this context, some investors have sought to improve returns by simply cutting the state-owned enterprises out of their investment portfolios. A common approach is to set a threshold for state ownership, such as 20%, and exclude all companies above that level.
While this method of portfolio allocation has some appeal in theory, it falls apart when measured against the complicated realities of state control in China.
Continue reading the full commentary.Nicholas Borst,
- The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.
- Nicholas Lardy, The State Strikes Back: The End of Economic Reform in China (Washington, D.C.: The Peterson Institute for International Economics, 2019).
- Gabriel Wilson-Otto, Siward Ludin, Linda Mulyani, Richard Manley, Derek Bingham and Christopher Vilburn, “Risks and Opportunities in China A-shares,” Goldman Sachs Equity Research, 10 June 2018.