Geopolitical risk continues to be top of mind for investors, particularly the shifting global balance of power from west to east as showcased by the escalating trade friction between China and the US. Charlie Awdry, China equities portfolio manager and Richard Clode, Global Technology portfolio manager, provide candid views on this evolving issue and its significance on how they invest.
Q: Which geopolitical risks concern you the most?
There's only one major geopolitical risk dominating China at the moment and that’s the US-China relationship. The focus is on trade but that’s just one element of this deteriorating relationship. Before, there was constructive engagement, now there’s strategic rivalry.
We've got friction, both at a trade level, but also at the geopolitical level of trying to influence politics in Asia and globally. The one area that I'm most concerned about is where China has a non-negotiable stance: Taiwan.
China sees Taiwan as part of China, but the Taiwanese see themselves as an independent nation with a strong political and diplomatic relationship with the US from which it buys much military equipment.
And Hong Kong (HK) where both Richard and I invest is at the fault line of it. HK is dealing with an existential issue of becoming part of China. From a financial/stock market point of view, HK is an avenue for foreign capital, both in and out of China, so on that basis we have to hope it maintains its role.
From an investment point of view, we should recognise that Hong Kong offers a lot of offshore capital, Chinese corporates have taken advantage of this and have balance sheets that are multi-currency. So as an investor based in the UK there is a currency risk should the yuan depreciate.
This superpower supremacy rivalry is going to be multi-generational. At the centre of it is technology, the control of it and the national security implications, which is President Trump’s main concern. We saw this with the blacklisting of Huawei (in May 2019 US companies were forbidden from supplying components to the Chinese telecoms giant. A month later it was announced the ban would be eased).
If you don’t control your own artificial intelligence (AI), that has huge implications across national security, defence, productivity of your country, surveillance, you name it. Trade is just the battle, the war is this wider jostling for supremacy.
Q: Can there be a resolution to the trade war?
Even if there is a trade resolution and China allows foreign technology companies into China, and removes subsidies for local companies to end unfair competition ‒ the enforcement of that will be challenging because ultimately both countries are diametrically opposed when it comes to their goals ‒ the US wants to maintain its current hegemony of power while China thinks that they should be ‘number one’. The two are not going to settle.
I agree. The US and China have different philosophies, different systems. Interestingly in the tech space, there is the development of almost two tech worlds, the US world and the China world. We already have that in the internet. In China, Google doesn't work. Google Maps won't get you anywhere; you have to use Baidu. That kind of ecosystem is something we have to start thinking about beyond just the internet.
Q: To what degree is the US-China trade war affecting your investments?
It’s clear that China has been unfair in terms of companies coming to play on a level playing field. Luckily for the Global Technology Team, this hasn’t had much impact on the companies we invest in.
This is because the silver lining to that unfair competition is that most of the tech giants like Google, Netflix, or Amazon effectively don’t have a business in China. What we’ve seen with the blacklisting of Huawei, is still how dependent Chinese technology companies are on US technology and US components, particularly semiconductors. Huawei’s entire 5G build is dependent on two US companies, Altera, which is part of Intel, and predominantly, Xilinx. Being self-reliant is a core part of China’s longer-term strategic plans. The negotiating position for the US today is as strong as it's ever going to be. I think China will get more aggressive when they start to become more self-sufficient.
And when it comes to semiconductors, Taiwan supplies major clients like Apple, Qualcomm, NVIDIA and HiSilicon (Huawei’s semiconductor division). There are limited alternative suppliers. The Chinese see Taiwan as part of China; as an investor in the semiconductor industry that is a key risk albeit the global ramifications would extend well beyond that.
The bigger picture here is that this strategic rivalry could create slower growth in China because there's less trade. However, China is quite a domestic economy already with consumerism, and there's also a lot of investment.
We also monitor the currency to see if the government lets it weaken to try and boost the economy. Because obviously that’s a headwind for us as we’re sterling-based investors buying yuan-denominated assets and profits.
But in the technology space, companies like Tencent, Alibaba, NetEase, they're not really cyclical. Most people think that China is a trading market, but I think these stocks over the years have been good buy-and-hold companies. Because we are domestic focused, our China portfolios are invested more in the Chinese internet ecosystem than the hardware global supply chain.
Q: Richard, is there a distinction between technology sectors?
I agree, not that many major global tech companies have big businesses in China. There are no software companies that sell much into China, the global internet companies aren't there. So it's really only the more cyclical areas that are affected, such as hardware and semiconductors. We’ve reduced our semiconductor holdings materially in the Global Technology Strategy mainly because in addition to the trade war concerns, the macroeconomic backdrop is deteriorating and inventory levels are high.
But the rest, as Charlie said, are mainly domestic-focused businesses. Alibaba (China’s Amazon) is often unfairly used as a proxy for China consumer and trade sentiment; they’re quite comfortable with their long-term (secular) growth trends.
When we talk to global companies like Microsoft we’re told the trade friction doesn't impact them much. It’s not really slowing the secular growth trends of technology, in fact it may even be accelerating some of the technology disruption we’re seeing. What’s exciting is that this desire for self-sufficiency in China may result in many more interesting Chinese technology companies come to market.
Q: So with uncertainty you are finding opportunity?
In recent years we’ve seen that most valid macroeconomic concerns tend to get priced into all equities. So even if we are cautious on certain sectors of the market, at the individual stock level we can often find some attractive companies. I think the opportunity in China is for active management, but it's because the environment from the top down is quite challenging, especially when it comes to geopolitical issues.
I would concur with Charlie on the need for active management. With geopolitics dominating the headlines these days we have a much more volatile investment environment. That’s where I believe an active investment manager with expertise and experience can really add some value. For example, the blacklisting of Huawei was a well-flagged risk and we were able to, in advance, reduce our allocation to semiconductors, a sector that would be affected by the ban. We know there are pockets of the market that are much more exposed to potential risk factors than others.
When there’s unquantifiable or unjustified reactions in stocks and markets then you can use that opportunity to buy. We did that at the end of 2018, when cyclical stocks were very weak.
Active management allows you to take action in advance of these trends, rather than as a passive investor, you're simply waiting for things to change.
Cyclical business: these companies generally do well in periods of economic prosperity and expansion and less well in periods of economic downturn and contraction.