Investors are growing increasingly concerned over China’s technology crackdown. Anthony Okolie speaks with Christian Medeiros, Portfolio Manager, TD Asset Management, about whether the crackdown presents an opportunity for emerging market tech unicorns.
CHRISTIAN MEDEIROS [00:00:12] Hi, Tony. Yeah, this is a really great question, and it's one of the biggest issues we've seen in markets this month. We've seen Chinese regulatory actions against DiDi, a recent listing in the US against their cyber security practices. We've also seen many of our actions against the for profit education sector that's crippled the industry. Both of these have resulted in serious underperformance for Chinese equities, as well as emerging market equities as a whole. And so this is leaving a lot of investors asking what's going on? What should we do here? And I think it's important to take a step back and think about the big picture and the geopolitical angle. And I think a lot of investors are maybe hoping, thinking, that post Trump, we would have much more reasonable relations with China. But the reality is, is that it's a consensus across Washington that we're going into a great power rivalry with China. This is going to be one of the prevailing themes of our time. And as a result, the Biden Administration hasn't been as bombastic as Trump, but they've maintained many of the same policies. And in fact, they've brought in them to newer issues such as technology, such as human rights, and bringing in many of the US's traditional alliances to bear. So while it's quieter, the relations are continuing to be tough and the rivalry is extending. So as a result, China as well as the US, it's a full societal effort. So in China, they are reconsidering how to do things more themselves and how to prioritize their own national interests. And so in doing so, they need to make sure they fine tune their local economy, make sure that everyone is on the same page. And some of the major issues that they need to tackle are issues of social importance and also issues such as technology, which is a major battleground. And so China is not going to necessarily pay attention to capital markets to reach their long term geopolitical objectives. They're going to be focused on what matters to them as a country. And so as a result, we're going to see some backlash and knockon effects on the policy front.
ANTHONY OKOLIE [00:02:11] And I'm glad you mentioned technology, because we've seen the crackdown by the Chinese government on technology. Do you see this crackdown as transitory or is it a wake up call for investors?
CHRISTIAN MEDEIROS [00:02:23] That's a great question. I think tactically, in the short term, some investor concerns are overdone. There's not a critical, horrible risk in the short term to US listings and to Chinese tech companies. I think things will calm down a bit, especially given that there's a leadership retreat right now in China. But over the longer term, I think we do need to keep in mind that there is going to be more policy both in the US and in China that's going to affect Chinese tech companies. We saw that under Trump with actions against Huawei and TikTok. We see current congressional actions against Chinese companies listed in the US. And then in China, we're going to continue to see issues. And there's rumors now about threats to the gaming industry and other smaller industries, too. So we can expect this to continue. And I think on the on the technology front in China, the biggest tech companies, if you think about it, they control most of the high technology. They control a lot of consumer data, and they're also important for social welfare of the average Chinese person. So if the Chinese party is concerned about the social issues in the country and what they do with data and how they keep tech in line with national interest, it's important that those are regulated. So I think we can expect regulation to continue and investors really cannot be complacent.
ANTHONY OKOLIE [00:03:41] And could China's latest crackdown forced investors to give emerging market technology unicorns a second look?
CHRISTIAN MEDEIROS [00:03:49] Definitely, definitely. I think something that Vitaly and I have been arguing for a long time is that the emerging market benchmark, especially in equity space, is so dominated by China and dominated by Chinese growth firms. And a lot of investors don't look beyond that to the other countries and the countries in that index. And I think we think that that's a mistake because there's a lot of really interesting companies out there. And now that there should be a higher policy risk premium on Chinese equities, hopefully investors look to these other countries. And so, for example, a lot of these companies that we've talked about in the past offer similar platforms like those in China, but they have more newer markets to expand into in many different technologies that they're rolling out. And so we see companies like Mercado Libre and Sea Limited in Latin America and Southeast Asia, respectively, who performed relatively well during this emerging market sell off. And we also can see in other countries, like in India, there's a lot of new listings and IPOs because there's many tech unicorns that are coming to market. So if you broaden your emerging markets go beyond just China, you'll see a lot of exciting companies that not only offer, earlier in their growth story, not only offer interesting new technologies, but are also overlooked by many investors. So I think a lot of investors in the EM space should migrate over to the rest of emerging markets to look for new growth names.
ANTHONY OKOLIE [00:05:11] Very interesting point, Christian. So does China's regulatory crackdown make China's tech stocks less attractive versus emerging markets?
CHRISTIAN MEDEIROS [00:05:19] That's that's a good question. I think you do need to pay a higher risk premium when you're investing in Chinese tech companies partially because of the variable interest entity structure, which I don't personally think is under threat right now. But it could be a contentious risk in the future. And then the other issue, too, is that in the US Congress, there has been legislation. That means that a lot of the companies that are US listed from China, they need to have more scrutiny over their auditing papers. And so there is risk that they could be delisted in the future. So given that headwind, given that you're going to have more regulatory action and control from China as they try to keep technology in line with our national interest and really bolster that rivalry with the US, you're going to have to contend with all these policy risks. And so as a result, I think that does warrant a bit of a higher risk premia that investors may have been paying in the past.
ANTHONY OKOLIE [00:06:13] So given all these challenges, do you see this as a stock pickers market?
CHRISTIAN MEDEIROS [00:06:18] Yeah, I definitely do. I think in the world of more decoupling and world with more policy and a world with more geopolitics. You do really need to pick your spots and you do need to find opportunities in different areas of the globe. It's not just one global system. We're going to have spheres of influence between the US, China and markets in between. And policy action will need to be monitored because all it takes is a quick regulatory action from China or a new legislative priority from the US, or some sort of skirmish, and you can see markets going to a short term tailspin. So as a result, I would look to emerging markets and developed market growth companies that are overlooked beyond US and China because they're going to want to make sure that they build their own champions, not rely on US and Chinese companies that are going to be more and more influenced by the state. You're going to want to also keep in mind that the cross pollination of technology between the US and China won't really be there. And so they'll be distinct opportunities in both markets that investors can play. So I think there's different markets and different opportunities, and it really should empower investors to be more global in mindset and also really pay attention to that policy going forward.
ANTHONY OKOLIE [00:07:27] Christian, thank you very much for your time.
CHRISTIAN MEDEIROS [00:07:31] Thank you, Anthony.