Charlie Munger has been talking about the attractiveness of China’s equity market, and it’s been a great place to fish for the past couple of years. I moved back to China at the end of 2017 and have been focusing exclusively on China’s equity market. Before that I spent most of my time on the U.S. market. I’m starting to feel Munger is absolutely right. While competition has picked up in China, it’s still much more inefficient than the U.S. market. Here are a few important factors of the attractiveness of China’s market.
First and obviously, the best Chinese companies have been growing much faster than the great U.S. companies. In the U.S., high single-digit top-line growth is considered very good, but in China anything below 15% is considered mediocre.
Second, if we look across emerging markets, China has a relatively stable political environment and stable currency. The Chinese government plays an incredibly important role here, which may be vastly misunderstood by non-Chinese.
Third, as mentioned above, many industries and companies have benefited from the great industrial revolution of China and are now globally competitive.
And fourth, the Chinese market is much more volatile because there are many investors who can’t tolerate volatility and drawdowns, which is great for value investors who have the right temperament. There are a few structural factors that contributed to the inefficiency:
- Gambler’s mindset.
- Distorted institutional performance evaluation system.
- Language and cultural barrier for foreign institutional investors.
- Retail investors dominate trading volume.
- Limited supply – small percentage of floating shares.
- Frequent policy impact
For example, we can take a look at two important factors – demand and supply, which we can use trading volume breakdown and ownership structure as proxies.
Proportion of Trading Volumes by Investor Type – China A-share
On the trading or demand side, 80% of the trading is done by retail investors. And on the supply side, government and corporate ownership is high, and very often these are usually not tradable. The float can be a very small portion of total shares outstanding. On top of that, retail investors make up the largest portion of the shareholder base. You can see why the equity market is less efficient in China.