The recent regulatory crackdown across sectors in China has been a major disruptor to the Chinese equity story. The State Council’s recent five-year blueprint and the accelerating pace of announcements may suggest that the ongoing regulatory risks could be a medium-to-longer-term overhang for Chinese stocks broadly. Top-down risk bucketing can help to identify/mitigate potential risks. In order to help investors monitor/hedge risks associated with continued regulatory momentum, we have divided up the liquid Chinese universe (MXCN+HSCI ex HK) across a number of top-down cohorts: SOEs vs POEs, VIEs vs Non-VIEs and sub-industries with positive, neutral and negative regulatory trends. We have created tradable baskets on each. We estimate that 44% of MSCI China weight is in sub-industries with negative regulatory momentum. 47% of weight uses the VIE structure. MSCI China names may face more risk given (1) the higher weight of US-listed names and (2) the higher free-float of stocks that use VIEs or are in targeted sectors (e-commerce, online games, fintech, etc.). For our overall China universe, we estimate that 18% of the market cap utilises VIEs and 21% of names by cap are in sub-industries with negative regulatory/policy momentum. Trade ideas: (1) We tactically prefer A-shares to offshore stocks, given lower policy risk (only 4% of A-share market cap is in sub-industries where we see a significant negative policy risk). (2) Hedge further negative regulatory trends/VIE risk with tradable baskets. (3) Look for idiosyncratic ideas from within our universe of stocks where we see neutral policy risk. (4) Focus on long/short positioning-based strategies that should benefit from the rotation into more policy-friendly stocks (Southbound Sentiment/Northbound Alpha).
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