How will you stay invested in China-focused funds?

China and India are often compared as competitors when it comes to trade, but there are situations when one feeds off another. Mutual funds with exposure to China or Asia-Pacific focused schemes with exposure to Chinese firms are niche investment products, but they are used by a set of Indian mutual fund investors to get geographical diversification. For the past 12 months, such China-exposed funds have not given any reason to smile. With Apple's Inc., world's largest company by market value, announcing that it is lowering its fiscal first-quarter sales expectations on account of China's faltering economy, is this a canary in a coal mine moment for Indian MF investors? DNA Money talks to investment experts who feel that a US-China trade war have strong growth implications which should not be ignored by investors.

Chinese whispers

There are many international equity funds available for Indian investors. One of the niche areas are China and Asia schemes. Some funds that fit the bill include Edelweiss Greater China Equity Off-shore Fund, Reliance ETF Hang Seng BeES, Franklin Asian Equity Fund and HSBC Asia Pacific (Ex Japan) Dividend Yield Fund. When it comes to exposure to Chinese companies (including those of Hong Kong), such funds often have investments in Chinese firms like Alibaba, Tencent, HSBC, China Mobile, Ping An Insurance, Bank of China, CNOOC, AIA Group, ICBC, to name a few.

Over the last few years, Chinese firms in the internet/e-commerce, energy and financials space have attracted investor interest. But, in the last 12 months or so, China has become an uncomfortable word for investors. The Hang Seng index is down 15% in last one year. The Shanghai Composite index is is down a steeper 25% in the same time. Naturally, China funds have been laggards. For instance, Edelweiss Greater China Equity Off-shore Fund is down 20.56% in the year ended January 8. Franklin Asian Equity Fund, with key holdings in Alibaba, Tencent and Ping An Insurance, is down 17% in last one year.

Experts are divided on whether China MFs are suitable for investors. There are advocates and detractors. China-focused MFs definitely unlatch the doors for domestic investors and are a good route for investment, says Swapnil Aggarwal, director, VSRK Wealth Creator.

However, financial investment expert Rajesh Sharma disagrees. "If you look at five-year returns, China-focused funds are not doing anything earth-shaking. Some of them have also become quite small in size as investors have gone to greener pastures. India focused MFs have done much better," Sharma argues.

While Apple has made noise about China, things are not in black and white anymore. "China has been a sore-point for Apple for quite sometime now. Now, Apple has talked about economic deceleration in Greater China. It also talked about how the economic environment in China has been further impacted by rising trade tensions with the United States. For all you know, this could be something else. Apple is a huge company, but its beef with China may be a company-specific issue," says international trade expert Vikram Thakur.

Slowdown is for real

The Chinese economy is led by five chief industries/sectors - financials, properties & construction, information technology, energy and telecommunications. When it comes to attracting investor capital, these five areas are favourites. But a slowdown in China's growth is a real issue, notwithstanding what Apple said. A World Bank report estimated that China's economic growth will slow to 6.2% in 2019 from 6.5% in 2018 as domestic and external rebalancing continue.

V K Vijaykumar, chief investment strategist, Geojit, said: "The Chinese slowdown is a major concern for the global economy in 2019. After impressive growth in 2018, the global economy is almost certain to decelerate in 2019. The US, which re-emerged as the engine of global growth, has been on the second longest period of economic expansion in US history. But a slowdown appears imminent in the US too. The flattening of the yield curve in the US indicates a slowdown. Global PMI in December, at a two-year low, is another indication of an imminent slowdown."

China's loss may be India's gain. Even though this 'growth scare' is negative, it has positive implications for stock market performance in Emerging Markets (EMs) like India. The growth slowdown is likely to turn the Fed's monetary policy stance dovish in 2019. The Fed has already trimmed the number of rate hikes they foresee in 2019 from three to two. "The sharp dip in US 10-year yield – from the peak of 3.26% in October to around 2.7% now has stemmed capital outflows from EMs. The declining yields are likely to trigger increasing capital flows to EMs. EMs are likely to outperform Developed Markets (DMs) in 2019. This augurs well for Indian stock market since India is on the cusp of an earnings recovery. A Chinese slowdown will deflect FII money from China and other EMs like South Korea and Taiwan which will be impacted more by the Chinese slowdown, to India which will be least impacted by the Chinese slowdown," adds Vijaykumar.

Amid the US-China trade war scenario, investments in China-related firms at such times may not be optimal, feel some experts. Paras Bothra, president, equity research, Ashika Capital says: "The trade war between US and China is not limited to their own economies but will surely affect the global GDP on account of disruption in supply chains across the world. Most importantly, the trade war could weigh heavily on sentiment for corporate deals in next year if the US & China are unable to reach an accord soon. Besides, there is always a possibility of companies moving manufacturing facilities out of China to lower-cost countries in Asia. Like for Apparel and footwear, the shift has already started with increased sourcing from Bangladesh, Vietnam, India, Pakistan and the Philippines."

Some feel that pockets in China could offer value for investors. One of these pockets are Chinese bank stocks. Country focused MFs investing in banks could make good money. "China's banking sector is trading close to historical lows for both H- (Hong Kong exchange listed) and A-shares (listed on Shanghai or Shenzhen stock exchanges) due to continued book value increases. The A/H premium remains at a high level. We think now is a good time to add China banks in the investment portfolio given the attractive upside potential and decent dividend yield at 5-6%," said Morgan Stanley in a research report.