- Recent regulatory changes in China are aligned with its 14th Five-Year Plan that aims to shift the country from a high-speed to a high-quality model for economic growth.
- Our analysis of MSCI China All Shares IMI Thematic Indexes' performance showed that the regulatory changes had a more profound impact on social and lifestyle themes compared with technological-innovation-related themes.
- The historical crowding levels show that the outperforming themes such as future mobility and efficient energy continued to exhibit a high level of crowding since the beginning of the year.
Recent regulatory changes in China have some investors — including those focused on long-term, structural, transformative themes — wondering how different industries could be affected. Overall, we found these changes were related to China’s latest development agenda, the 14th Five-Year Plan (2021-2025).
The latest plan established technological innovation as a key driver of long-term economic growth and emphasized social welfare, security, equality and green development as key aspects of sustainable growth. In this context, the regulatory changes, shown in the exhibit below, were also targeted at the social aspects of China’s plan for long-term growth.
Summary of Recent Regulatory Changes
|Internet Plus||Prevent monopolistic behaviors, stop anticompetitive practices, safeguard consumer interests and promote data safety|
|Education||Improve schools’ education and training quality and regulate after-school tutoring services|
|Health Care||Provide guidelines for oncology-drug trials and research|
|Housing||Eliminate housing speculation and excessive leverage|
“Internet Plus” refers to the application of the internet and information technology in conventional industries, and was introduced in a Chinese-government work report in 2015 to promote and support the development of internet and information technology. It affects companies such as Alibaba Group Holdings Ltd., Tencent Holdings Ltd., Meituan and JD.com Inc.
New Regulations Through a Thematic-Investing Lens
We analyzed the historical performance of the MSCI China All Shares IMI Thematic Index suite and found that the digital-economy, next-generation-internet and millennials themes underperformed the parent MSCI China All Shares IMI Index year-to-date while future mobility, efficient energy and robotics outperformed. The worst-performing themes year-to-date fall into the Chinese regulatory category of internet plus. On the other hand, the top-performing themes were not impacted by recent regulatory changes and fall under the categories of green development and industry upgrade, which were emphasized in China’s longer-term development agenda. The performance of the MSCI China All Shares IMI Tech Index was right in between given its integrated exposure to internet, mobility, industrials and health.
Performance of MSCI China All Shares IMI Thematic Indexes
Index inception dates: May 2018. Gross return in USD as of July 30, 2021, annualized for periods longer than a year.
What Drove Performance?
To further understand the near-term performance drivers, we used the Barra All China Equity Model1 to examine the year-to-date style-factor and industry attribution of the top- and bottom-three performing groups as of July 30, 2021. The active performance attribution from style factors shows that the top-performing group had high exposure to China A (domestically listed) beta and contributed most of the active performance, while most of the underperformance of the bottom group was explained by high exposure to China international (non-domestically listed) beta.
In terms of industry attribution, the exhibit below shows that positive exposure to China A electrical equipment, China international semiconductors and semiconductor equipment and China A hardware and semiconductors were the largest contributors to the top-performing thematic indexes. On the other hand, positive exposure to China international software and services, computer and peripherals and media and retailing were the main drivers of the bottom-performing group’s underperformance.
Industry Performance Attribution for Top- and Bottom-Performing Thematic Indexes
Data from Dec. 31, 2020, to July 30, 2021
Based on style-factor and industries performance attribution, we observed that overseas listed companies running an internet-plus, or so-called “soft tech,” business model were more vulnerable than the “hard tech” companies under recent regulatory changes.2
Insights from the MSCI Factor Crowding Model
As the market reacts to these changes, investors may have concerns about crowding within thematic investment themes. The exhibit below shows the historical weighted-average crowding scores of the top- and bottom-three thematic indexes through July 30, 2021.
Historical Crowding of Top and Bottom Performers
Data from Dec. 31, 2018, to July 30, 2021. The security-level crowding score was based on a stock-crowding model that incorporates valuation, trading volume, volatility, momentum and short interest.
There were steep increases in the crowding level of recent top-performing thematic indexes at the end of 2020, that coincided with the start of regulatory changes. Despite historically high levels of aggregate crowding for the top-performing thematic indexes, the valuation ratios were not overly stretched compared to the historical numbers since the index-inception date in 2018. As of July 30, 2021, the price-to-forward-earnings ratios of the top-performing themes were around the 80th percentile of those for the full period from Dec. 31, 2018, to July 30, 2021. On the other hand, the bottom-performing thematic indexes’ price-to-forward-earnings ratios as of July 30, 2021, were around the 60th percentile for the full period; this was not that low despite low levels of crowding, which reflects repricing of their earnings potential.
Different Themes Reacted Differently
Evaluating these new regulatory changes through a thematic lens can provide further insights into the growth and crowding levels of those megatrends, as industries react and evolve.
1The Barra All China Equity Model integrates domestic China (CNE5) and China International (CXE1) models.
2As opposed to an internet-plus, or “soft tech,” business model, “hard tech” companies focus on fundamental research and development in cutting-edge technologies in manufacturing, telecommunication, new materials, automation and robotics that can be utilized at an industrial level.