What are the risks to investing in Chinese stocks in 2021?

Equities

China’s main stock markets soared to a collective $10 trillion earlier in 2020, which has caused investors to turn to their gaze eastward. But should you be trading or investing in Chinese stocks in 2021? 

Should you invest in Chinese shares? 

The case for Chinese stocks 

China is the world’s second-largest economy, and the only large economy to forecast positive growth in 2020. The IMF forecasts China’s GDP to grow 1.2% by the end of 2020, although the figure may actually be closer to 2%. October’s World Bank report puts China’s economy on a growth footing for 2021 too, forecasting total GDP growth of 7.9% by the close of next year. Despite being the first country officially hit by Covid-19, China is also likely to be the first to fully recover. 

The nation also accounted for 49% of the world’s total global growth in 2019. Rather than being led by its traditional export-focused model – China exports goods every year worth more than the UK’s entire GDP – half of Chinese GDP is sourced from domestic consumption. 

China could overtake the US, economics-wise, in the next two decades if present trends continue. Equities may continue a strong upward swing. JPMorgan has predicted they will continue to deliver close to double-digit annual returns over the next 10-15 years. Using the past five years’ performance as an indicator, MSCI China All Shares has delivered an average annual return of 10.34% (although past performance is not necessarily indicative of future performance). 

While we’ve seen UK stocks may be poised to shine, some of the best Chinese stocks have mirrored the nation’s impressive growth and could prove even more tempting. Traders have identified the below as amongst China’s top-performing shares across the past year. 

  • Alibaba – Alibaba Group Holdings Limited is the largest retailer and e-commerce company in China. Alibaba operates some of the largest shopping platforms like Taobao and Tmall. Very few of those investing in Chinese stocks haven’t heard of Alibaba. The company’s stocks have gained 24.9% value, reaching $264.87 at close on December 10. At the time of writing, it had a price of $260.05. 
  • JD.com – JD is one of the biggest B2C e-commerce service providers in China and in the world in general. It’s also one of Alibaba’s chief competitors. It has been represented in 85 hedge funds so far this year, with a total hedge fund holding value of $13.57bn. 
  • GDS Holdings – GDS Holdings is a datacentre technology provider focussed mainly on the domestic market. 2020 has been a year of sustained growth for GDS with revenue growing 43% year-over-year in Q3 to hit $224.6m. As one of the fastest growers in its sector, GDS’ organic sales also completely surpassed 2019 totals by Q3. 

Other Chinese firms on investors radar include Google’s Chinese equivalent Baidu, EV builder Nio, Fast Food firm Yum! Holdings, tutoring service TAL Education Group, and video streaming platform BiliBili Inc.  

Chinese shares: some reasons for caution 

While tales of blistering economic growth and high performance on individual shares may be tempting, it’s potentially worthwhile taking a more cautious view when trading or investing Chinese shares. 

Firstly, the largest companies may no longer be listed on US indices. On December 19th 2020, President Trump, in one of his few remaining acts in office, signed a bill calling for foreign companies to be delisted if they fail to the same accounting transparency standards as US firms listed on US stock exchanges.  

As of October 2020, there were 217 Chinese firms listed on US exchanges with capitalisation worth $2.2 trillion. 

Under the terms of the Holding Foreign Companies Accountable Act, delisting could happen if a foreign firm refuses to comply with audit inspections three years in a row. Audit inspections are performed on other U.S.-listed companies by the Public Company Accounting Oversight Board, which was set up to prevent accounting scandals, like the infamous Enron scam, from happening.  

All very well and good, but China’s government does not allow the board to perform audit inspections of Chinese companies listed in the US. It will probably see this as a provocative move as tensions continue to simmer between the US and China. 

According to a report published by the US Government in October 2020, sixteen Chinese firms have already been delisted. Amongst these was Luckin Coffee, subsequently delisted from the Nasdaq, after investigators found the coffee house had reported $310m in fake transactions in financial statements. 

Transparency is a huge concern for investors when it comes looking eastward. The unfolding saga of GSX Techdu proves investors aren’t afraid to go short on suspect Chinese stocks if they get a whiff of fraud.  

The online education stock was one of the latest to fall under the investor cosh as sellers shorted positions against fraud accusations levelled at GSX. Investigative work from Muddy Waters Capital gave investors the blues after it alleged as much as 80% of GSX users were fake. Investors pulled out and sent GSX share prices tumbling. 

Outlook for investing in Chinese shares in 2021 

US-China tensions will colour everything going forward, particularly if China continues its massive economic growth. President-Elect Joe Biden has lined up long-time China critic Katherine Tai as the US’ next top trade official, suggesting a less than dovish approach will be taken by the Biden White House towards China. 

So, while investing in Chinese stocks has the potential to pay off, it may be worth taking a more cautious view going forward into 2021.