Insights / September 24, 2019

China: A Slowing-But-Steady Giant

A Rising Global Economic Force Still Faces Questions From Many Investors.

A widely told story of Marco Polo claims that, while on his deathbed, the explorer said of his adventures through early China, “I did not tell half of what I saw, for I knew I would not be believed.” While the quote may be little more than a fanciful myth, its popularity highlights a general sense in Western minds of China as a difficulttounderstand place full of mystery and intrigue.

Charles de Gaulle, the French war hero who led his nation against Nazi Germany, is also said to have expressed befuddlement with Chinese affairs. His fittingly statesmanlike summary: “China is a big country, inhabited by many Chinese.”

For many investors, considerations of investing in China may share a similar feeling of dubious intrigue. Indeed, the list of reasons not to bother with Chinese investments may seem to decisively outweigh any promise the country may hold. The average investor scanning recent headlines will find no shortage of reasons for misgivings.

Even beyond an ongoing trade war that has sent ripples of uncertainty throughout global marketsa sufficiently daunting reality, even on its ownthe autocratic bent of China’s form of governance can seem like a decisive departure for the investor longaccustomed to more open markets. It is precisely in response to this heavyhanded approach that protestors in Hong Kong have poured into the streets in recent months, for example.

Relatedly, even when moving beyond the most recent headlines, many investors may feel reservations concerning the Chinese government’s penchant for state control in certain industries, as well as its reputationrightly earned or notfor currency manipulation and other underhanded business dealings.

Why, then, in light of a seemingly overwhelming list of deterrents, should any investor undertake what may seem like a perilous venture? Why bother, given the uncertainty? Why, as an investor, should you care?


Officially, from 1973 to 2013, China’s gross domestic product (GDP) reportedly grew by between 9.5% and 11%. For some perspective, one would need to go back to the first three years of World War II to find American GDP levels eclipsing 9%. China has enjoyed such levels of growth for four decades.

The engine behind this economic growth has been China’s population of 1.4 billion and rapidly rising standards of living, as shown in the figure below. Extreme poverty in China declined from 88% in 1981 to roughly 2% in 2017, while average income skyrocketed by more than 4,000% during the same period.

This success story has led to rapid changes for the emerging superpower. China is already the world’s largest ecommerce customer. Among other records, it is now home to the world’s largest bank, the world’s largest mobile operator, and is also the largest market for automobiles in the worldincluding the largest market for American automobiles.

In reading about the financial crisis of 2008, positive stories are hard to find. Yet China is one of the few countries that, by most estimations, never experienced a formal recession, a feat it managed precisely as a result of its burgeoning domestic capacity, as well as significant government stimulus efforts.

In Forbes’s most recent global ranking of the largest public companies, five of the top 10 entries were Chinese companies.

This context is helpful when attempting to understand China’s recent economic slowdown. When compared to the preceding three decades, which saw the bulk of China enter an entirely new economic reality, China’s growth has certainly slowed. However, that “slow period” still represents 6.2% GDP growth and the creation of a “new Australia” every year. The U.S. last eclipsed the same figure in 1984, when GDP briefly peaked at 7.3%.

All told, China now represents the world’s secondlargest equity market (and secondlargest overall economy) and only continues to grow.


As part of its charm offensive aimed at fashioning itself as a more serious world player, China has taken numerous commendable steps to demonstrate increased openness and to liberalize elements of its historically insular markets. Chinese officials have overseen widescale deleveraging and deregulation campaigns intended to allow growing business sectors to operate with more autonomy, while the overall extent of control exerted by China’s stateowned enterprises (SOEs) has shifted downward.

According to Stratfor, SOEs’ “share of the gross domestic product fell from more than 50% to 25% in just 15 years; and they account for only 5% of industrial enterprises today, compared with 18% in 2003.” The Chinese government also claims to have closed more than 1,900 “zombie companiescompanies that are no longer operational or are unprofitable and often exist solely as a result of state supportmany of which were also SOEs. And in a bid to control debt levels, officials have also sought to tighten regional budgetary restraints, including attempts to cull reliance on the nation’s shadowbanking system.

In 2016, Chinese officials loosened restrictions on foreign investments by its citizens, allowing each individual to invest up to $50,000 overseas. More importantly for American investors, China has also taken extensive action to open its markets to the rest of the world.


The prospect of investing in China will only have appeared on the radar of most investors relatively recently, in large part due to these reforms. In 2003, through the Qualified Foreign Institutional Investor (QFII) system, China introduced two types of shares allowing foreign investors to invest in companies on the Shanghai Stock Exchange and the Shenzhen Stock Exchange: Ashares and Bshares.

Since their inception, Bshares have largely fallen out of favor, becoming a “zombie market” that is largely ignored, with Deloitte estimating that between 40% and 85% of Bshare companies may ultimately be candidates for conversion to the more commonly known Hshares on the Hong Kong market. For their part, Ashares spent the better part of a decade as a relatively obscure investment optionthe domain of the handful of organizations able and willing to meet Beijing’s restrictive standards for participation in the QFII program.

In 2011, China rolled out its Renminbi Qualified Foreign Institutional Investor (RQFII) system, which further opened the doors to the rest of the world. This unveiling was followed by further reforms, including expanded quotas and relaxation of various rules, in 2012 and 2013. In November 2014, China introduced its ShanghaiHong Kong Stock Connect initiative, allowing for crosstrading between the two markets. By 2017, following further reforms, Shenzhen Connect was also launched.

Overall, this flurry of developments has contributed to a seismic shift in China’s weighting in global indexes. In 2018, for the first time, MSCI added largecap Chinese Ashares to its indexes at an inclusion factor of 5%that is, 5% of the existing universe of Chinese Ashares. Following their initial inclusion, MSCI announced that it would incrementally quadruple the inclusion factor of both Chinese mid caps and large caps to 20% in November 2019.

All told, the changes will amount to the addition of 253 largecap and 168 midcap Chinese Ashares. And MSCI estimates that China’s inclusion factor within its indexes could rise to as much as 40% in the future.

The shift is undoubtedly a boon for China and its investors. Estimates place the increased inflows to China at potentially upwards of $80 billion.

Nor does China appear poised to slow down its outreach efforts. In June 2019, a nascent, asyet morelimited version of the Stock Connect initiative launched, connecting Shanghai to London. China has also announced that it intends to further simplify the system by merging its QFII and RQFII initiatives.

Combined, the Shanghai and Shenzhen exchanges already represent roughly 10% of total world market capitalization, with the exchanges bringing more than 1,500 potential new companies into the global investable universe.

Impressively, Ashares have historically higher returns than their Hshare and ADR counterparts, while simultaneously boasting similar to lower volatility. Also notable is the fact that, despite the increased levels of integration brought about by China’s efforts to open to the world, the Chinese Ashare market has thus far shown a potentially desirable lack of correlation to other markets, both developed and emerging, thus offering prospective diversification against existing developed– and emerging– market strategies.


Within China, some areas that have shown consistent promise and growth include information technology, health care, and financial technologies and services. Analysts seem generally confident in those areas reliant on Chinese consumer demand, which is estimated to increase by $6 trillion between now and 2030, according to McKinsey & Company.

On technology, China has made a respectable effort of dispelling notions that it somehow lacks the ability to innovate. China’s venturecapital (VC) spending rose from $12 billion to $77 billion between 2011 and 2016, accounting for 19% of the worldwide total. In 2017, VC spending dipped to $62 billion, but remained within striking distance of the United States’ roughly $84 billion in VC spending. Some estimates predict China could surpass the U.S. in the category as soon as 2020, potentially hitting $130 billion in venturecapital spending compared to a predicted $100 billion by the U.S.

This spending includes considerable investment in AI, big data and financial technologies. Chinese consumers have shown a considerable appetite for cloudcomputing services. For all its dystopian implications, insofar as data is king, China may knowingly be sitting on a goldmine. Indeed, China already boasts nine of the top 20 largest tech companies in the world.

As shown in the figure below, as of 2017, China leads the world in total patent applications with nearly 1.4 million, more than doubling the United States, which ranks second. To put this number into context, China’s total number of patent applications in 1997, twenty years prior, was just 24,774.

Signs of innovation are also clear when one considers that, from 2016 to 2018, the capital formation brought about by Chinese IPOs was $1.5 trillionmore than three times the amount generated by U.S. IPOs over the same time period. Alibaba’s $25 billion IPO in 2014 marked the highest in history, narrowly edging out the IPO of another Chinese entity, the Agricultural Bank of China, which had established the record just four years before with its $22.1 billion IPO in 2010.

Given China’s demand for digital payments and widespread use of online lending services (singlehandedly accounting for threequarters of the global demand), fintech investments hold considerable upside. And many of the consumers seeking these services belong to a sizable, aging population that has steadily accumulated new wealth. This same segment of the population is likely to continue to fuel the embrace of emerging financial services and healthcare offerings.

While Chinese incomes and standards of living have risen substantially, China requires potentially decades of additional growth to compete in this arena with developed countries. China’s modernization and digitalization initiatives also remain a work in progress. From an investment standpoint, this means that huge swaths of China, including rural areas, have yet to feel the full impact of the economic upswing, promising future room for growth.

Consider one simple statistic: China is currently on track, by 2020, to compete with the United States to become the top global marketplace for digital payments. It has managed this feat despite only 54% of its population having access to the internetand a delayed start, at that.

China’s current standing strongly suggests that many of the businesses currently performing well within the Chinese market may be positioned to expand not only geographically, across China, but also to expand into the market share vacated by those companies who have fallen victim to the country’s economic growing pains. Good deals on longterm Chinese prospects continue to abound for the shrewd investor willing to do the work.


The Chinese economy often seems to be one of multiple personalities, in part because it is, with the country attempting to move from an export– and manufacturingbased economy to an economy based on the types of domestic production and services that have largely spurred its incredible economic expansion.

Where the Chinese government can get out of its own way, the Chinese economy tends to flourish. Yet Chinese officials can’t seem to entirely move away from “business as usual,” occasionally to the detriment of China’s stillburgeoning markets.

For example, one joint study from the University of Hong Kong and the University of Chicago suggests that China’s muchvaunted GDP numbers between 2008 and 2016 were exaggerated by, on average, 1.7 percentage points. And various Chinese officials’ statements on the matter have done little to inspire confidence outside Communist Party meetings.

This is a common theme, highlighting the way the priorities of China’s oldschool statists often conflict with the priorities of China’s newschool entrepreneurs. The financial truth underlying China’s inflated PR spin is often still plenty impressive. China’s economy truly is a success story. But when the needs of the Chinese state intermarry with Chinese business interests, all involved parties tend to suffer. These types of political intrusions into China’s economic affairs only serve to undermine the confidence of the same investors China hopes to win over.

Similarly, despite China’s aforementioned efforts at reducing state control, there remains considerable work to be done. Although officials’ claims of having dealt with 1,900 zombie companies are commendable, thousands of such entities reportedly remain, with concerns surrounding the widespread economic impacts of shuttering such a large number of businesses.

Moreover, though the reported decrease in the breadth of China’s state control may initially sound positive, it could perhaps just as validly be thought of as a consolidation of power away from certain sectors and toward others, rather than a relinquishing of power. As Stratfor also notes, despite the reduction in the number of Chinese SOEs between 2003 and 2017, SOE assets increased tenfold to roughly $10.4 trillion. And the same SOEs are responsible for the vast majority of China’s borrowing, which now has the nation rushing to control its considerable debt levels.

Nevertheless, we view the overall direction as both positive for investors, and note that the decrease (and/or consolidation) of state control has increasingly confined state involvement to sectors in which we have not traditionally invested heavily.


Concerns over China’s growing pains as it shifts toward more open markets did not go unnoticed by MSCI, when the organization added Chinese Ashares to its indexes and subsequently increased Chinese weightings. Continued integration will ultimately hinge upon China’s ongoing ability and willingness to further open up its own markets, while balancing its own internal stability. MSCI “stressed that a future weight increase of China Ashares in the MSCI indexes…would require Chinese authorities to address a number of remaining market accessibility questions.”

All told, the picture that emerges seems to be one of a Chinese market that is wrestling with an identity crisis and (perhaps inevitable) slowed expansion, while still possessing immense headroom for future growth. While the shortterm outlook is difficult to know, given ongoing political realities, investors are not likely to turn away from China in the near future, particularly if the nation’s leadership continues to value progress on its economic reforms as a means of maintaining its own institutional power.

The overall market in China is not growing as quickly as it once was. But within the immense market that now exists, following decades of explosive growth, those companies that have survived the turmoil can represent very promising longterm investment options. China still retains the power of its immense domestic market, which continues to strengthen. Given the recency of China’s economic explosion, the nation remains an “emerging” market. As such, the population lags somewhat behind more developed countries in the embrace of some goods and services.

We believe investors may further benefit from a level of homogeneity not present in other emerging markets, where more intense regional differences can stymie business efforts to become a national influence and fully capitalize on the size of the nation’s immense population. China, while culturally diverse, appears to be generally of a similar mind in adopting new trends as they emerge.

The simplest and most honest answer for, “Why should you care about China?” is, “Because China is too big to ignore.” New market realities, including China’s steps to open to the world and subsequent changes to global indexes, strongly suggest China’s international role only stands to increase.

With that increase in standing comes an increase in expectations that China can be a transparent international partner. Whether in slaying “zombie markets,” “zombie businesses” or any number of other undead economic ghosts of its recent past, China’s leaders ultimately have it within their sole power to make the right policy decisions that will continue to foster growth and innovation. We are optimistic that, despite the shortterm uncertainties, China will continue to move incrementally in the right direction.


For all its bluster and posturing, the success stories coming out of China are not mere myth. There are certainly risks associated with investing in Chinaas there are risks with all investments. However, for all of the apparent foreboding accompanying investments in China, we also sincerely believe that the perception of risk is greater than the actual risk. As is so often the case, the pendulum of the truth generally tends to settle somewhere in the middle of two extremes.

For example, while the reputation of China’s currency has suffered due to its routine politicization (again highlighting the occasional conflict between the health of the market and the machinations of the state), the reality is considerably more positive. Compared to the U.S. dollar, the renminbi has displayed lower exchangerate volatility than the Indian rupee, the Russian ruble, the Brazilian real and the Mexican peso, since at least 2005.

Because the Wasatch legacy is first and foremost “bottomup,” we are primarily concerned with finding companies that are individually excellent. As such, we weigh the investment risks facing every individual company every time we consider adding a Chinese holding to one of our strategies. This approach served us well when we began as a firm focused primarily on micro– and smallcap stocks.

Since our founding, we increasingly and successfully applied that same bottomup approach across international markets, such as Indiawhose economic growth story shares many similarities with China’s. Following a long period of intensive analysis and research, Wasatch ultimately launched an Emerging India strategy, and subsequently leveraged that gained knowledge and experience across our other strategies.

These lessons have informed our approach to China, and we believe the combination of our detailoriented smallcap legacy and our extensive experience in emerging markets combine to represent a considerable competitive advantage. In seeking to once again duplicate this methodical and rigorous Wasatch approach, we have made it a priority to expand and strengthen our China research team. We are proud to count two native Mandarin speakers among the members of our worldclass staff.

We also believe it essential to conduct routine, thorough ontheground research. Our Multiple Eyes™ approachand a culture rooted in academia that actively encourages dissentmeans we habitually send teams of analysts with notably diverse viewpoints to conduct research into prospective investments, thus providing a richer and more honest account of a company’s upsides and downsides.

In the past 12 months alone, Wasatch has sent eight analysts on 11 research trips to China, during which our team met with 150 individual companies.

Across our strategies, both domestic and international, we occasionally receive comments from management teams regarding how rare it is for them to receive an actual inperson visit from potential investors. Our experience in China has been no different. In fact, our insistence on such deep due diligence has meant that our analysts have sometimes been the first potential investors with which the management teams at some of our prospective Chinese investments have ever met.

We recognize that economic realities in China are complex and evolving. China is not a perfect fairytale. Recent headlines are correct, insofar as they intimate concerns with some of the current economic and political realities China faces.

We also recognize that the headlines don’t tell the whole story. Indeed, our position is one of wise, cautious optimism. With Chinese growth and domestic consumption poised to continue, albeit likely in a somewhat more restrained manner compared to its soaring highs, we anticipate some incredible opportunities to participate in what we believe is one of the world’s most impressive economic success stories. More importantly, we believe we are uniquely positioned to take advantage of these plentiful and promising opportunities.




Investing in foreign securities, especially in emerging markets, entails special risks, such as currency fluctuations and political uncertainties, which are described in more detail in the prospectus. Investing in small and micro cap funds will be more volatile and loss of principal could be greater than investing in large cap or more diversified funds.

Diversification does not eliminate the risk of experiencing investment losses.

An investor should consider investment objectives, risks, charges, and expenses carefully before investing. To obtain a prospectus, containing this and other information, visit or call 800.551.1700. Please read it carefully before investing.

Information in this document regarding market or economic trends or the factors influencing historical or future performance reflects the opinions of management as of the date of this document. These statements should not be relied upon for any other purpose. Past performance is no guarantee of future results, and there is no guarantee that the market forecasts discussed will be realized.

ALPS Distributors, Inc. is not affiliated with Wasatch Global Investors.


Gross domestic product (GDP) is a basic measure of a country’s economic performance and is the market value of all final goods and services made within the borders of a country in a year.

The Shanghai Stock Exchange is the largest stock exchange in mainland China. It is a nonprofit organization run by the China Securities Regulatory Commission (CSRC).

The Shenzhen Stock Exchange, based in Shenzhen, Guangdong, is one of China’s three stock exchanges. The other two are the Shanghai Stock Exchange and the Hong Kong Stock Exchange.

China Ashares, along with Bshares, are sold on mainland China’s two stock exchanges, which are in Shanghai and Shenzhen. The key difference between Ashares and Bshares is that Ashares are denominated in mainland China’s currency, the renminbi, and Bshares are denominated in foreign currency (U.S. dollars in Shanghai and Hong Kong dollars in Shenzhen).

Hshares refer to the shares of companies incorporated in mainland China that are traded on the Hong Kong Stock Exchange. Many companies float their shares simultaneously on the Hong Kong market and one of the two mainland Chinese stock exchanges in Shanghai or Shenzhen. Such companies are known as A+H companies.

The ShanghaiHong Kong Stock Connect is a mutual market access program, through which investors in Hong Kong and mainland China can trade and settle shares listed on the other market, respectively, via the exchange and clearing house in their local market.

The MSCI Emerging Markets Index is a free floatadjusted market capitalization index designed to measure the equity market performance of emerging markets. You cannot invest in this or any index. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI.

An American Depositary Receipt (ADR) is a negotiable certificate issued by a U.S. bank representing a specified number of shares in a foreign stock that is traded on a U.S. exchange.

Multiple Eyes™ is a Wasatch term used to describe the firm’s collaborative culture and research process.

An initial public offering (IPO) is a company’s first sale of stock to the public.