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What Does China's Tech Crackdown Teach Us About Investing?

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Last fall, on the eve of what could have been the most professionally important day of his life, one of the world’s richest men went missing. The billionaire was Jack Ma, and he was about to lead the largest initial public offering in history by listing his online payment venture Ant Group on the Shanghai and Hong Kong stock exchanges. Instead, Chinese President Xi Jinping suspended the IPO, Ant Group lost almost $70 billion in value, and Ma wasn’t seen for months. What followed was one of the wildest upheavals in stock values in recent memory, if not ever.

Rumour had it that Ma had angered Chinese regulators by making public comments criticizing the country’s financial industry, accusing banks of having a “pawnshop mentality.” In the months that followed, as Ma avoided the public eye, his remarks seemed to have stirred a sleeping giant. Beijing started issuing and enforcing regulations primarily aimed at the tech sector, sparking chaos in the international markets. As the government cracked down on antitrust violations and data privacy, Chinese tech companies found themselves facing steep penalties. Alibaba, the parent company of Ma’s Ant Group, was fined $2.8 billion and forced to restructure. (Ma resurfaced early this year.) China’s huge online tutoring industry, meanwhile, wondered whether it could continue to exist at all; government leaders believed that the platforms eroded China’s public-school system by poaching teachers and exasperated educational inequalities.

There are now so many companies caught in the government’s crosshairs it’s hard to keep track: Didi, a ride-hailing app, was suspended in early July for violating data-security rules. Meituan, a food-delivery company, faced new regulations on worker standards. Even Tencent, one of China’s biggest tech companies, found its massively popular gaming and messaging platform WeChat under scrutiny. In May, hundreds of apps were put on notice for potential user-data violations. Even though some of the affected apps aren’t widely used outside China, the crackdown has sent shockwaves through markets, wiping out $1 trillion in value; the Hang Seng tech index dropped 17% in July alone.

Investors are trying to decide whether it’s still a sound idea to invest in Chinese corporations if the government can, and is clearly willing to, flatten an entire industry in mere months.

What exactly is the Chinese government hoping to achieve?

The rout has prompted tons of speculation about why the Chinese government suddenly decided to crank up regulatory pressure on the country’s tech companies. Some observers hold that China may believe that its tech sector, and online tutoring platforms specifically, not only undermines its public education system but may also, in a very roundabout way, exacerbate its declining fertility rates. (The idea is that tutoring platforms are hugely expensive, but parents believe their kids need them, so they have fewer kids to ensure they can afford the cost.)

Other watchers contend that, with the recent crackdowns, China is simply doing what the U.S. has lacked the will to do: regulating an extremely powerful industry that’s grown algorithmically in the past few decades and operates with few checks on it. In a widely shared note on LinkedIn, Ray Dalio, of the hedge fund Bridgewater Associates, wrote that the Chinese government was putting the needs of its society ahead of the market, explaining, “Those in the capital markets and capitalists have to understand their subordinate places in the system or they will suffer the consequences of their mistakes.”

The subtext of such discussions — and the reason why everyone is weighing in — is that investors are trying to decide whether it’s still a sound idea to invest in Chinese corporations if the government can, and is clearly willing to, flatten an entire industry in mere months. The long-term answer hinges on the government’s motivations. If the government has narrow goals — like mitigating data-security concerns or elevating birth rates — the risk is probably conditional and limited. If that’s the case, companies that comply with the government’s new regulations will be able to protect their businesses, at least presumably. But if the government’s motivations are largely ideological, and if it hopes to tamp down on “capitalist excesses,” the risk could be systemic.

What are stock traders and long-term investors doing?

In the short term, with the government’s motivations unclear, there’s no guarantee that any one specific company won’t find itself in the hot seat. This uncertainty has led some stock pickers (the best of whom, for what it’s worth, are typically wrong as often as they are right) like Cathie Wood, head of the investment management firm Ark Invest, to dump their Chinese holdings. Prominent hedge funds, including Soroban Capital Partners, have followed suit. But many big, long-term investors have taken a longer view. This month, BlackRock, the world’s largest asset manager, doubled down on China, encouraging investors to boost allocations there by two or three times, given the potential returns. And, to date, no major Canadian institutions have announced big shifts out of China.

The answer to “Should I dump all my Chinese stocks” is that you’re asking the wrong question.

The most compelling case for stomaching the risk of holding Chinese stocks might ultimately be neither terribly exciting nor novel but is something wise investors perennially encourage: diversification. If you’re diversified, the Chinese crackdown probably means very, very little to your portfolio. China’s tech-heavy index has fallen. But the Chinese stocks across the board haven’t — hence BlackRock’s bullish position. Broad-based tech exchange-traded funds (ETFs), moreover, have escaped the tech rout almost entirely unscathed, as the Financial Times recently pointed out, since these funds weren’t narrowly invested in a handful of companies.

The Chinese tech industry had a major downturn, no doubt. That’s surprising but also not, because sectors around the world have downturns all the time for various reasons, which is why you diversify. Geographically diversified portfolios reduce exposure to such sector- and country-concentrated downtowns and benefit investors long term. And, by nearly every measure, a diversified global portfolio continues to make sense, especially since China doesn’t seem to be reversing its support of most private-sector businesses — just those in tech. (Wealthsimple intends to remain invested for this reason; it also intentionally limits its exposure to country-concentrated risk in emerging markets, like China.)

Put differently, choosing individual winners and losers in the Chinese economy has certainly grown dicey for stock pickers like Cathie Wood. But that doesn’t mean you’ll lose money on a diversified set of global companies. In the end, what matters most, in terms of your portfolio, is the long-term economic growth of the countries where you’re invested. And for that, one country has grown faster and more consistently than any other: China.

Jessica Camille Aguirre is an independent journalist whose writing has appeared in The New York Times Magazine, Wired, Vanity Fair, and elsewhere.

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