China stock crash has wiped nearly a third off the market's value: How much do UK investors in Asian funds need to worry?

By Tanya Jefferies for Thisismoney.co.uk

Published: 11:34 EST, 9 July 2015 | Updated: 05:06 EST, 10 July 2015

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Chinese markets have suffered days of chaos and draconian measures by the Communist authorities to put a floor under plunging stock prices.

Calm was just about restored on the Shanghai market by last night - but only after 50 per cent of stocks were suspended from trading, while company bosses and major investors were banned from selling up for the next six months.

The share rout has wiped nearly a third off the value of the market since mid June, but it was preceded by a year-long rally generating dizzying gains. So just what is going on and how worried should investors be about money stashed in Asian funds?

Stock watch: Chinese market is dominated by private investors who have piled in using a lot of borrowed money

Why has China's market crashed?

Losses in recent weeks might look huge, but they follow a doubling in the value of the main Shanghai index since last summer, while at the same time the pace of economic growth has slowed.

The Chinese market is dominated by private investors who have piled in using a lot of borrowed money to scoop up stocks, something known as buying on margin.

When this practice gets out of hand it becomes an accident waiting to happen, because any sell-off is worsened by investors having to ditch stocks to pay back their debts.

Arguably, many individuals with brand new trading accounts have been treating stock markets as a casino to gamble in rather than as a means of investing for the long term.

After a big run-up in prices and a fairly predictable correction, the Communist authorities then found it harder than expected to control a market full of inexperienced and panicked private investors.

Measures to enforce stability have included not only the widespread stock suspensions and a selling ban for bigger investors, but an interest rate cut, restrictions on new company listings, forcing fund managers to buy $19billion of blue chip stocks, and an increase in the liquidity available for margin lending.

Market exposure: UK investors tend to hold Asia-wide funds - sometimes but not always excluding Japan - spreading their risk rather than putting too much in China alone

What does this mean for investors in China and Asia Pacific funds?

China keeps foreign investors out of the Shanghai market, so if you have invested in the country it is likely to be in companies listed in Hong Kong.

The Hang Seng hasn't been immune from the turmoil, but it's dropped about 10 per cent as opposed to the Shanghai market's 32 per cent fall since mid-June.

On top of that, UK investors tend to hold Asia-wide funds - sometimes but not always excluding Japan - spreading their risk rather than putting too much in China alone.

However, it's worth noting the impact of tanking Chinese shares on global commodity markets. Oil, copper, silver, iron ore and other prices have fallen due to concern about diminishing demand from the world's biggest commodity buyer.

The FTSE 100 is laden with resource stocks so UK investors will have taken a hit on this front in recent weeks, even though it hasn't been much noted due to the Greek crisis causing volatility closer to home.

Jason Hollands, managing director of Tilney Bestinvest, says because Greece has dominated the news of late it's been quite easy to overlook what's happening in China.

Under Communist control: 'China is a command economy not a free market economy,' says Jason Hollands

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But he suggests the developments in China and the prospect of a rate hike in the US are probably bigger issues than Greece in the scheme of things.

Regarding the drastic measures taken by the Chinese authorities to stabilise markets, Hollands says: 'It's a reminder that China is a command economy not a free market economy.'

He reckons China needs to rebalance its economy because GDP growth has depended too much on exports and internal investment in infrastructure.

'GDP growth has come essentially from projects like property development, infrastucture, roads to regional cities, or grand projects to build opera houses in regional cities,' he says.

To those interested in Asian funds (excluding Japan) he says having exposure of 10 per cent would be 'ballsy' and long-term investors should have no more than 10-15 per cent in their portfolio. He says it's worth taking a look at the following funds:

First State Asia Pacific Leaders - Asia not including Japan, but including Australasia

Aberdeen Asia Pacific and Japan Equity - 24 per cent in Japan

Liontrust Asia Income - 55 per cent in China, but as it looks for dividend-paying companies it tends to include higher quality names with strong cash flow

What do City experts say?

Communist party shows its ineptitude in dealing with stock markets

China's markets are seeing 'insane volatility' and measures by the authorities to check the sell-off are turning out to be counter-productive, according to CMC Markets analyst Jasper Lawler.

'Over 50 per cent of Chinese-listed firms have suspended trading, and this number is likely to rise. Leveraged investors [those who borrowed to buy shares] are now trapped, unable to sell any of the 1,500 suspended stocks that will inevitably be losing value with the broader markets.

Crackdown: China Securities Regulatory Commission headquarters was visited by police to investigate clues that suggest "malicious" short-selling of shares

'This forces the investors to sell other holdings, that perhaps without intervention they may have held onto or even bought more of on the dip. The result is that declines are exacerbated.

'It goes without saying that movements in the Chinese stock market don’t necessarily correlate to China’s economy. This applied on the way up when Chinese stocks rallied over 100 per cent in the space of a year while economic growth was the slowest in six years.

'This should also be the case on the way down; just because stocks are crashing, it doesn’t necessarily have a knock-on effect on China’s economy.

'The wider concern is a loss of faith in the Chinese government. The bubble in China’s stock market was a creation of the government, and they have now unwittingly popped it.

'If the supposedly omnipotent Communist Party have shown such ineptitude with regard to stock markets, who’s to say the same thing won’t happen with the wider economy? If China’s authorities do lose control of the economy, it will have huge negative implication for global growth, and by implication global stock markets.

'China’s economy is still expanding faster than all developed nations, and there will be the inevitable dead-cat bounce in stock markets, but the fragility of a command economy has been exposed again.'

'It is never wise to fight the market'

'China seems to be going through the various stages of grief in relation to the stock market rout,' says Chris Beauchamp, senior market analyst at IG.

'The previous form of the People's Bank of China points to major action on its way at the weekend – so far the fallout has been financial, but any rumblings of political discontent will cause concern in Beijing and increase the pressure to act.

'It is never wise to fight the market, but there is no shortage of enthusiasm in China for unconventional measures that might stem the tide of selling.'

Beauchamp noted that China had managed to bring about a temporary respite, with markets rallying on news of government instructions to major shareholders to hold off on share sales.

'If this is followed up by fresh liquidity measures then further panic selling may be averted, but the turmoil of the past week is a salutary reminder that the still-immature Chinese equity market is not an area for the faint-hearted.'

Trading gloom: Share rout has wiped nearly a third off the value of the Shanghai market since mid June

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China's move to ban stock selling is 'truly breathtaking'

'If anyone was under any illusions that we're living in free global markets then China's recent policy actions should be a reminder that we're not and haven't really been for several years,' says Deutsche Bank credit strategist Jim Reid.

'Global financial markets are not really operating under capitalism but then again I'm not really sure I know what you'd call the system we are currently living under.

'A simplistic analysis of the problems over the last couple of decades is that bubbles are repeatedly being inflated by policy action and then never allowed to deflate properly when they turn.

'To be fair China is only doing what the West did a few years ago when they banned the shorting [betting stocks will fall] of things like various company equities and sovereign CDS [credit default swaps, used to insure against debt defaults].

'However China does seem to be raising the bar in terms of intervention techniques. One such example came yesterday after the China close with the news that the China Securities Regulatory Commission has banned major shareholders (with stakes of more than 5 per cent), corporate executive and directors from selling stakes in listed companies for six months. A truly breathtaking initiative.

Visit abroad: Chinese President Xi Jinping is in Russia to attend the 7th leaders' meeting of BRICS - Brazil, Russia, India, China and South Africa

'For us the China situation is more potentially worrying than Greece for global markets but overall it fits with our view of intervention and high liquidity being needed across the globe for many years to come.

'Don't be surprised by more Chinese major policy initiatives over the coming days. If Greece does go towards the exit door, expect the ECB to further aggressively intervene.'

China should see 'modest success' in attempts to boost GDP

Jeremy Lawson, chief economist at Standard Life Investments, suggests China is currently the biggest threat to the global economy.

'A hard landing in China would obviously be a large negative shock for the global economy, representing as it does 12 per cent of global GDP and 18 per cent of global manufacturing exports.

'Some countries stand to lose the most from any failure of China to stabilise growth. On the commodities front, countries like Australia, Brazil, Canada, Chile and Peru stand out.

'In manufacturing - Hong Kong, Korea, Malaysia, Singapore and Taiwan are most exposed, whilst developed economies like Germany export a sizable amount of capital goods to China.

Change is underway: Government has stepped up the pace of structural reforms - liberalising the financial system, cracking down on corruption and loosening fiscal policy

“There is good news – our research shows that most of the emerging markets are in a much better position to withstand external shocks than they were in the 1990s, thanks to improved fiscal and monetary frameworks.

'Overall, the government has stepped up the pace of structural reforms - liberalising the financial system, cracking down on corruption and loosening fiscal policy, albeit in a targeted way. As a result we expect there to be modest success in boosting GDP although the longer-term glide path is towards slower growth.'