A sweeping wave of regulations is coursing through China's tech sector, leaving investors bewildered. But knowing what speed bumps to expect can help you cushion the ride.
When China's Didi Global Inc made its long-anticipated debut on the New York Stock Exchange in June, it marked yet another big win for the Chinese technology sector. The ride-hailing giant raised a whopping US$4.4 million, becoming the second biggest Chinese firm to list overseas after Alibaba Group Holding's US$25 billion initial public offering (IPO) in 2014.
But things quickly unravelled. Just two days after Didi's IPO, China's cybersecurity regulator announced it started the investigation of the company and later, accused the company of improperly using customer data.
Now, China's government is reportedly looking to take control of the ride-hailing giant – the latest move in a nationwide crackdown on tech companies that involved others like Ant Group, Alibaba, Tencent, and Pinduoduo.
The unprecedented clampdown has sent stock markets into a frenzy over past months, with the Hang Seng Tech Index down by more than 40 per cent since hitting a peak in February. How should investors make sense of all this?
Regulatory uncertainty a key risk
The tech sector has grown to become a significant driver of China's economic growth, especially amid the COVID-19 pandemic – but so have regulations and policy changes.
In late August this year, for instance, the Chinese government introduced new rules banning children and teens under 18 years old from playing online games for more than three hours a week, with the aim of protecting the mental and physical health of minors.
It is difficult to predict how the ongoing wave of regulatory moves against the tech sector will end, said Maybank Group Wealth Management's Senior Investment Strategist Eddy Loh, noting that regulatory risk is a key overhang for the Chinese companies now.
"But further clarity on the regulatory front should help to improve visibility and lift sentiment on the sector," he said. Patience will be key.
Brace for volatility
For now, investors should brace themselves for more volatility in the market as tech companies continue to come under scrutiny.
"Any rebound may be capped by the policy uncertainties," said Ms Irene Foo, Head of Investment Strategy and Research at Maybank Group Wealth Management. Market analysts have also downgraded their forecasts for Chinese tech companies' earnings to reflect the negative impact of the new regulations as well as increased uncertainties.
Investors who are unable to tolerate the near-term volatility or are over-exposed to Chinese tech stocks may consider trimming their exposure.
The long game
That said, there are still reasons to stay invested in China for the longer term.
Pointing to how China's digital economy has become a major growth engine, accounting for nearly 40 per cent of the country's GDP in 2020 and contributing significantly to employment, Ms Foo believes the government "will be careful to not over-regulate and stifle the growth of the broader tech sector".
The long-term structural prospects of the sector are unlikely to be disrupted as well. "The tech sector, including the Internet companies, has been a key driver of innovation in China, contributing not only to the policy aim of stimulating consumption but also achieving technology independence," she said.
"Many Internet companies still have strong growth potential, fuelled by their proven innovation capabilities and their ability to expand and diversify their total addressable market."
It might look chaotic now but the best thing for investors to do is to stay calm and learn from the incident's lessons.
One is simply that there will always be volatility, which is why having a long-term investing perspective is important to help investors steer their portfolios through volatile times.
The episode also outlines the importance of maintaining a diversified portfolio to manage risks. This applies to not only investing in China equities, but also to other markets and asset classes, said Mr Loh.