Volatility in China: Deal Breaker, Necessary Evil or Opportunity?

Whether we are referring to anything from asset prices to the legislative dimension, volatility is most definitely something one cannot ignore in China, more so than in more mature Western jurisdictions. Some investors choose to stay away from China altogether for this very reason (in other words, volatility represents a deal breaker)

As far as assets and asset classes are concerned, we need to understand that most markets (practically all of them) are quite a bit less mature in China than in the West and as such, an inevitable binary consideration emerges:

1. On the one hand, opportunities abound and those who are on the right ends of the various deals that are to be hand in immature markets stand to generate career-defining returns
2. On the other hand, these (potentially) high returns come with a greater risk factor and volatility is to be expected

… the same principle is valid when it comes to all sectors of the Chinese economy that we can consider immature or maturing.

On top of that, there is of course a “China-specific” layer of politics-induced volatility or, in other words, the fact that the legislative dimension is far (far!) less predictable in China than in democratic jurisdictions. Perhaps one of the textbook examples to this effect is represented by the cryptocurrency world, with China frequently oscillating between downright banning certain dimensions of crypto (exchanges, mining and so on) and making it clear that blockchain technology is worth adopting to the point of even banning articles that criticize blockchain technology itself.

Once again, a binomial observation arises:

1. On the one hand, entire industries can be just one proverbial stroke of the pen away from being essentially wiped out. Once again, the cryptocurrency world provides textbook examples, with many highly resource-intensive mining operations being jeopardized by China cranking down on this activity
2. On the other hand, few things are set in stone and today’s frowned-upon activity can end up becoming tomorrow’s “promising industry” or in other words, the “opportunity” dimension is once again in the spotlight. Even more so, well-positioned players can actually make #1 work in their favor by, for example, purchasing highly complex cryptocurrency mining operations with their respective infrastructure (data center, equipment, etc.) for pennies on the dollar and putting them to good use when (if) the right time comes

… the list of examples could go on and on.

At the end of the day, it’s all a matter of how risk-tolerant you as an investor are:

1. As mentioned previously, some investors are so risk-adverse that even if the know opportunities abound in China, they choose to stay away for wealth and perhaps sanity preservation. While there is ultimately nothing wrong with that, it tends to be difficult to put together a meaningfully-diversified portfolio this way, let’s not even mention the opportunity cost dimension represented by the risk of ignoring mega-trends such as those in China, while other investors are laughing all the way to the bank and profiting from them
2. Other investors consider volatility in China a necessary nuisance or, in other words, they dislike but tolerate this volatility. For most investors, a compelling case could be made that this represents the most balanced approach. After all, investors don’t have to love volatility, they just need to know how to incorporate this dimension into their strategy and treat it as any other variable
3. The let’s call them “bravest” investors (although several outside observers would rather use terms such as “reckless” to describe them) are actually excited about a jurisdiction and/or asset class that puts a great deal of volatility on the table because they build entire business/investment models around making volatility work in their favor. While this sounds excellent in theory, our team would like to make it clear that it is easier said than done in China for the average Western investor who has read a handful of articles and is ready to call himself an expert on all things China. What exactly do you believe makes you stand out as an investor in China? Do you have any kind of edge that puts you at a competitive advantage compared to other market participants? What about experience, for how long have you and/or your organization been conducting business in China? When it comes to most Western investors, the answers to such questions tend to be less than impressive, which is why we do need to stress that talking the proverbial talk without walking the walk is a surefire path to ruin

It is ultimately up to each investor to decide how he positions himself with respect to volatility.

If category #1 best describes you, then while it is your right to choose any approach you deem appropriate, our team firmly believes this particular approach (staying away from China for volatility-related reasons) is sub-optimal at best and would strongly advise against excessive rigidity.

As far as category #2 is concerned, as mentioned previously, we consider it the optimal approach for most Western investors. As much as we believe that China represents the elephant in the room of our generation in terms of investment potential, we would advise against being a “one trick pony” as an investor by limiting yourself to just one jurisdiction. “Smart diversification” is the operative term in our view.

Finally, moving on to category #3, we most definitely believe that the potential is there but we just as firmly believe most Western investors are not well-equipped enough in terms of experience and deep understanding of “all things China” for this approach to represent a good fit. At the risk of sounding eager to self-promote, we would strongly recommend working with consultants such as the ChinaFund.com team, with a hands-on experience in China of over 12 years. The same way, we believe those best-represented by categories #1 and #2 would also stand to gain by at least booking a few hours of our time and are looking forward to working with customers across the entire risk tolerance spectrum.