Chinese Internet – the Boom and Bust Story

Chapter 1 – The success story

The competitiveness of China compared to the western world has been widely discussed in several areas such as semiconductors, EVs or 5G technology. However, one additional area where China has become a big success story is the development of a domestic internet ecosystem. The Chinese internet space is the only real competitor to the global hegemony of the US internet behemoths, as even the self-grown internet platforms in countries such as Korea or Japan can hardly be considered equal. There are multiple structural reasons why China has succeeded where most others have not – these reasons include the considerable size of the Chinese market (the most populous country in the world and the world’s 2nd largest economy), distinctive language and writing system, different preferences of consumers and, very importantly, the reluctance of the US internet behemoths to localize their products (which were successful in the west) to the specifics of the Chinese market – Google was a prime example of this.

The resounding success of the Chinese internet juggernauts has also led to massive gains for many investors, especially in the initial phases, such as for the South African Naspers – the company which has built its fortunes around its early investment in Tencent, the largest Chinese gaming and messaging company. The Chinese internet space gained wider attention in the western investment community back in 2014, at the time of the US IPO of the largest Chinese e-commerce platform Alibaba. The IPO heralded the advent of the ‘golden age’ of the Chinese internet. In the years that followed (notable 2016 to 2020), the Chinese internet platform stocks rallied and led the emerging market’s returns. The weight of the Chinese internet platforms in the MSCI EM index even exceeded 20% and and one could often find a simple strategy to beat the index among the top-performing EM funds – holding large weights in the big Chinese internet platforms, hoping that the Chinese internet rally would continue. At the same time, the first cracks in the Chinese platforms success story started appearing. Several segments of the Chinese internet space had already entered the maturation phase (e.g. the Chinese e-commerce penetration level became the 2nd highest in the world, only lagging South Korea – raising doubts about additional growth potential) and the founders of the Chinese internet behemoth became increasingly bold after amassing huge wealth, which necessarily leads to rising influence, which could step on the toes of the country leadership in Beijing. We believe some index-beating EM funds of the 2016-2020 era could have built their success on going big on the Chinese internet platforms, and did not see these potential risks brewing, or worse, ignored them as they were unable or unwilling to find a different way to outperform the index focusing on stock selection. In the meantime, the boom part of the Chinese internet sector story was coming to an end.

Chart 1: The largest MSCI Emerging Markets index (MXEF) weights as of September 30 2020 (around the top of the Chinese internet rally) – the MXEF index was heavily dominated by the Chinese internet names as 5 out of the 8 top names were related to the Chinese internet platforms and the overall MXEF weight of Chinese internet platforms exceeded 20%

Source: Bloomberg as of September 30, 2020