Mark Williams

Should investors in China worry about the Hong Kong protests?

Mark Williams

Hong Kong Protests

On 3 September 2019, Xi Jinping – China’s most powerful leader since Chairman Mao – sat in front of a cohort of aspiring officials at the Central Party School and asked them to prepare for a struggle. Ahead of two 100-year milestones – the centenaries of the Communist Party of China in 2021 and People’s Republic of China in 2049 – Xi Jinping wanted to prepare the class for a number of risks. Of those he listed, one five-word item will have grabbed the attention of any international eavesdroppers: “Hong Kong, Macau and Taiwan.”

While China is ostensibly committed to “one country, two systems” in Hong Kong until 2047 - the 50th anniversary of the region’s handover from the British - it is clear that some political independence is already being eroded.

Six months of protests in Hong Kong have shone a light on the issue but discontent with mainland China’s influence is nothing new. In 2014, the Umbrella Revolution held a series of protests in response to proposed reforms to Hong Kong’s electoral system. Hong Kong’s constitution states: “The socialist system and policies shall not be practised in the Hong Kong Special Administrative Region, and the previous capitalist system and way of life shall remain unchanged for 50 years”. But in the first 20 years following Hong Kong’s return to China, Taiwan’s Mainland Affairs Council – admittedly an extremely biased source – estimates there were more than 200 violations of “one country, two systems”.

Should investors in Hong Kong be worried? The answer depends on whether you are investing in Hong Kong’s economy and businesses, or if you are using the Hong Kong Stock Exchange to access Chinese companies.

If it is the former, then the recent protests are a source of significant disruption that further cloud the outlook for an economy that recently slipped into recession. The direct impact on businesses is clear for everyone to see: they are losing trading days as demonstrations cause buildings to be shut, and tourist numbers from mainland China and overseas are significantly down.

However, for those who, like us, invest in Chinese companies via the Hong Kong exchange, we think the implications are less concerning.

As investors in China, we have for many years been aware of its clear intentions towards greater influence over Taiwan and reunification of Hong Kong and Macau.

These intentions have become more visible as Xi Jinping has consolidated power. Recent years have seen the two-term limit on presidency removed and ‘Xi Jinping Thought’ added to the school curriculum. While this is a positive in enabling the more efficient execution of necessary policies such as economic reform, it also allows him to pursue his goals in Taiwan, Hong Kong and Macau with more purpose.

However, the prospect of tension or conflict is a recognised risk that is already factored into Chinese share prices. The recent unrest in Hong Kong suggests that a flash point could be closer than previously assumed (and not as far away as 2047), but it should still be far enough down the road to only justify a small risk discount. It certainly is not enough of a negative to offset the significant positive drivers supporting investment in Chinese shares.

On both sides of the recent Hong Kong unrest, there are motivations to prevent events escalating. For a start, the protests don’t seem to have the support of Hong Kong’s elder generation, who would prefer to trust China’s promise to leave them alone until 2047 and who see increasingly violent demonstrations as potentially inciting more intervention. Looking at it from China’s perspective, we think it will want to avoid military intervention for the simple reason that it cannot yet replace Hong Kong as an international finance gateway.

The Asia Income Fund remains around 40% invested in the H shares of Chinese companies listed on the Hong Kong Stock Exchange and recent events in Hong Kong have not shaken our conviction in this position. Indeed, the Hang Seng China Enterprise Index of such H shares is up 7% in local currency terms since the protests began six months ago.

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Tuesday, December 17, 2019, 10:49 AM