Yet Justin Leverenz, manager of the $51 billion Invesco Developing Markets fund (ticker: ODMAX), is bullish on China and Asia. Although he began trimming his stake in Alibaba Group Holding (BABA) because of competitive concerns before Beijing’s latest regulations threatened China’s largest internet companies, he sees a bull market in Chinese equities ahead, propelled by cash-rich domestic buyers. He also expects to see a revival in commodities prices that could reverse emerging markets’ decade-long rout.
Leverenz’s fund returned 14% last year, lagging peers. But his record is impressive: The fund has outperformed 94% of peers in the past 15 years, returning an average of 7.6% a year, according to Morningstar.
He recently discussed with Barron’s why he likes Chinese stocks, which technology stars are emerging beyond China, and what investors are missing about commodities companies. An edited version of the conversation follows.
Justin Leverenz: It is a polarized environment, with China apologists and the tourists—those who don’t have to get involved, and call [China] uninvestable. I sit in between. While much of [the regulation] came in a dizzying fashion, China is going to have an uber bull market in the next five to 10 years. Investment will be domestic in nature.
The less-talked-about part of regulations is the focus on not increasing leverage in the system and reconfiguring growth
. Part of that is increasing restrictions on property speculation. Chinese households have the second largest balance sheet in the world. That is going to shift to equities, much as it did in the U.S. in the 1980s and 1990s, and drive a significant bull market. A multi-year transformation of the asset allocation of households in China will drive prices. Why would one not be part of this explosive opportunity?
It’s anomalous that a country as large as China has its most important companies inaccessible to domestic savers [because they are listed on non-Chinese exchanges]. The effort to create a domestic market, albeit offshore in Hong Kong, and therefore control capital flows more easily, is an important part of the calculus.
China’s biggest objective is to become independent in an increasingly hostile world. China needs to deal with its fragilities: energy, semiconductors, and [the dominance of] the dollar.
China wants to create a deep, liquid capital market. It is the largest trading nation, but almost all trade is in dollars and euros, and it wants to move some of that into the renminbi. But people, governments, and corporations don’t have the ability to hold the RMB in any liquid fashion [due to capital controls]. The Hong Kong market is designed to enable the renminbi to be a more important international currency.
I don’t think China has any interest in harming the development of Hong Kong as a domestic offshore capital market because it is critical to China’s geopolitical circumstance.
The U.S. thinks, appropriately, that there are certain norms in behavior, whether related to Hong Kong, human-rights violations in Xinjiang, or Taiwan, whereas China sees these issues as matters of domestic sovereignty. It [says the U.S.] has its own social and civil-rights issues, and that we should live in a pluralist world and not infringe upon sovereignty.
Even the China apologists haven’t recognized that this regulation is favorable to cash flows. It will allow [previously] destructive competition to become a lot healthier. While growth will be lower, it will be much more focused on realistic profitability. There will be a tradeoff in valuations, but cash flows will be substantially higher.
Tencent’s core business—its gaming platform—is reasonably defensible, even when there is increased focus on the time usage of minors. [China’s new policy limits online gaming to three hours a week for all children.] Tencent has fingers in all the great game companies around the world as an investor, and as a publisher that can bring those games into China.
The other main levers of Tencent [advertising and investments in other companies] are under stress. China’s economy is going to slow. Plus, this aggressive, unruly, and destructive competition is going to be at bay. That means advertising [becomes less crucial] and will be under cyclical stress.
The other part, under structural stress, is Tencent’s listed investments in big companies such as JD.com [JD], Pinduoduo [PDD], and Sea Ltd. [SE]. Tencent is one of the most successful venture capitalists on the planet, but that game will be difficult in the next couple years. Its capacities in this new environment, which is anti-platform companies, are probably circumscribed.
The regulatory onslaught has another, deeper purpose: redressing inequality in China. From 1980 to the global financial crisis, there was a huge amount of social mobility—up until the past 10 years. Another way of thinking about the Xi administration is that it is like the FDR administration. It is oriented toward rebirthing the equality of opportunity in China, whether for political purposes or populism or the guiding hand of development. You are going to witness considerable redistribution in society—and that will be advantageous to the lower end of consumption, like quick-service restaurants, travel, and hotels.
Hotelier Huazhu Group [1179.HongKong] and Yum China Holdings [YUMC], which owns quick-service restaurants, are the largest players in fragmented industries with tremendous organic growth.
Huazhu is unbelievably tech savvy, which drives down costs and improves customer satisfaction. It is largely a franchise network. It has 10,000 hotels and can grow to 15,000 to 17,000 hotels in the next five years. The company also has a huge membership system and can fill a majority of nights at high occupancy levels in a non-Covid world.
People will freak out about the next couple quarters of growth. But over the next five years, China is going to generate 4% to 5% annual growth. It is the world’s big growth story.
Emerging markets, excluding China, have lagged the S&P 500 by 10 percentage points in the past decade. Why shouldn’t investors give up?
Emerging markets ex-China have been in a funk because of commodity prices, which are going to be on a tear. That will lift much of the non-China world, including Russia, the Gulf states, Latin America, Indonesia, and South Africa.
One of the biggest themes of our lifetime is related to climate change and the energy transition. It’s the opposite of the past three decades, which were all about technology, [which is] deflationary and requires little labor. This transition is perhaps going to be the most capital-intensive investment humanity has ever made.
We are going to be in a massive commodities cycle for a long time, not just because of the resource intensity of [renewable] projects but because supply has been constrained as commodities companies have been restrained [by shareholder preferences for dividends and cash flows over mergers and investment.]
In the past 10 years, Vale had been focused on expansion and market share rather than realizing profits, but [recently] it has communicated that it is focusing on cash-flow generation, not market share. You will see long-term iron ore prices go from $60-70 a tonne to $100-$150. Vale has reduced its debt, which means its double-digit free-cash-flow returns will be paid to shareholders. It’s an extraordinary investment.
Bourses that were stale now [offer] a different set of investment opportunities that will be appealing. In Brazil, top companies include PagSeguro Digital [PAGS] and MercadoLibre [MELI], and asset manager XP [XP]. Nubank is rumored to be going public in the fourth quarter. In South Korea, new companies are listing, such as gaming company Krafton [259960.Korea], e-commerce company Coupang [CPNG], and internet giant Kakao [35720.Korea]. In India you have food-delivery firm Zomato [543320.India] and at least a dozen unicorns rumored to go public in the next 12 months. In Southeast Asia, there’s Sea, but also GoTo and Grab, going public through a SPAC [special purpose acquisition company].