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As difficult as Chinese equities have been over the past year, weakness in the health care sector has been notable.

While President Biden’s announcement of a plan to boost US biomanufacturing sent shares of Chinese health care companies tumbling over recent weeks, this is just the latest in a string of concerns plaguing the sector. Since the peak of the market in June 2021, health care is down more than 60% to end September (see chart), making it the worst-returning sector in China over this period.

Despite this decline, there is still optimism about select opportunities in the sector. In this paper, we outline the drivers of this market decline and reasons for believing in the long-term outlook for the sector, and highlight some of the company-specific characteristics that investors might wish to consider when investing in Chinese health care today.

Understanding the market decline

Pressure on Chinese health care companies over the past year has seemingly come from all angles and often overwhelmed strong clinical trial data, sales figures, and company fundamentals. Major areas of concern include:

1. Macroeconomic risks, including recession fears, have caused global biotech funding to dry up

Following five years of strong growth, Chinese companies are currently feeling the effects of a global biotech downturn even more than their US and European counterparts. The global backdrop of rising rates, higher inflation and possible recession, matched with the specific macro challenges China is facing (including its zero-COVID policy and a property squeeze), has led to a fall in financing for innovative health care companies, especially earlier-stage, unprofitable businesses. Investors are fleeing to safe havens and less willing to fund unproven innovation. In such an environment, lower-quality and unprofitable biotechs have been most vulnerable and are less likely to secure funding.

The flipside, however, is that profitable biopharma companies with strong balance sheets may see opportunities to acquire these businesses at very attractive prices.

2. US trade and investment restrictions for sectors including biopharma

Beginning in late 2021, 11 Chinese biopharmaceutical companies were added to a US ‘entity list’, banning these from exporting certain US technology. This was part of some attempts to make it more difficult for the Chinese government to secure cutting-edge technology. Earlier this year, 33 Chinese entities were also added to the US’s ‘unverified list’ on the grounds that the end use of goods exported from the US could not be verified. Biopharma companies were among those listed, including WuXi Biologics units in Wuxi and Shanghai.

There has also been negative news flow relating to Chinese stocks listed on US exchanges, including several biotech companies (such as BeiGene, HUTCHMED and Zai Lab). In 2020, the Holding Foreign Companies Accountable Act became law in the US, under which failure to comply with the standards set out would trigger de-listing. This includes allowing the US’s accounting watchdog to perform company audits and, in March 2022, the US Securities and Exchange Commission identified several Chinese biotech companies as facing potential de-listing as a result. Ongoing US regulatory fallout has driven share price declines in some of the most established Chinese biotechs.

3. Domestic Chinese policy and regulation

Alongside geopolitical and macroeconomic factors, Chinese domestic policy has also driven down share prices in the health care sector. Negative sentiment has spilled over from the government’s regulatory response to platform companies and the tutorial sector. Investors fear drug and consumable pricing will be negatively impacted by a primarily focus on achieving ‘Common Prosperity’ goals.

Improving the cost efficiency of the health care industry has been a key priority for regulators in China, and they have focused on fostering true innovation in medicine and improving patient access to drugs. This has included establishing an essential drugs list, sold at cost. Over recent years, policy has focused on targeting drug prices, leading to concerns the domestic pharmaceutical industry could be subject to future price controls.

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.