In the first quarter of 2025, the MSCI China index rallied by 15%, outperforming global markets. However, in the second quarter, it was relatively flat, increasing by only 2.1%, and lagged behind global and Asian indices. This underperformance was attributed to ongoing tariff uncertainties, involution in the e-commerce and food delivery sectors, which impacted benchmark heavy weighted names, weaker-than-expected Chinese macroeconomic data, as well as the underwhelming policy stimulus so far.

Despite these challenges, investor interest in China has been growing with measured optimism, as private sector sentiment has improved in recent months. The significance of the private sector has been reaffirmed by senior policymakers at the recent World Economic Forum, coupled with the symposium convened by President Xi Jinping with leading Chinese entrepreneurs back in February and the introduction of the first-ever legislation for privately-owned enterprises in late April. This law aims to promote private companies and stabilize confidence and expectations for private business owners, aligning with the recent easing of regulatory pressures on the private economy. Additionally, China's anti-trust and M&A frameworks have become more transparent in recent years.

Why offshore equities: Exposure to dynamic growth themes

While domestic demand requires more than just better private sector sentiment, especially as broader consumer confidence only shows moderate improvement amid a sluggish property market, elevated youth unemployment, and ongoing income uncertainty, the nature of consumption within China has evolved, and new structural themes have emerged. Consumers are shifting their spending behaviors to be more rational, selective, and value-oriented. Notably, we observe some “new consumption” opportunities that have led the MSCI China Index’s entertainment and specialty retail sectors to new peaks post-Covid reopening in 2023 (+85% and +57%, respectively¹) (Exhibit 1).

• Affordable luxuries: Domestic electric vehicles, smartphones and hotel chains are gaining market share from premium global brands as consumers become more price-sensitive in the current deflationary environment, emphasizing value for money.
• Paying for experiences and emotional value rather than pure functionality: Consumers are increasingly willing to invest time and money in personal experiences that enhance emotional value. They indulge in small and affordable delights, such as blind boxes, plush toys, online games, cosmetics, and new snacks, which address stress and loneliness, providing comfort, instant gratification, and a sense of belonging to the growing “Gen Z” consumer group.
• Globalization of Chinese intellectual properties: Technology breakthroughs by low-cost, high-performance Chinese artificial intelligence startups, the unprecedented success of the domestic animated movie Ne Zha, and China's innovation capabilities in drug development and biotechnology all point to the expansion of intellectual property (IP) portfolios, product innovation, monetization, and globalization, which will serve as key drivers for China's IP development moving forward. As Exhibit 1 illustrates, soft tech leaders and Chinese biotech innovators rallied 30% and 28%, respectively, since Covid re-opening and have risen 20% and 56%, respectively, year-to-date. 

Why onshore equities: Stability through dividends and policy support

When global markets experienced tremendous volatility during April's tariff turmoil, onshore shares demonstrated a higher degree of resilience. This was largely due to stabilization efforts by the National Team, which mitigated market volatility after the U.S. tariff policy announcement. Consequently, onshore equity returns have exhibited greater stability relative to offshore equity in recent months, while still delivering modest yet positive returns year-to-date.

This defensive nature for onshore equities extends to its abundance of high yielding sectors and industries, such as energy and financials (Exhibit 2), which offered up to 6.7% and 4.8% dividend yields, respectively, offering a way of dividend-orientated investment to compound returns. As onshore investors continue to explore various income strategies, these high-yielders provide a sizeable positive carry spread over Chinese government bonds, which have seen continued demand pushing 10-year yields towards 1.65% levels. This dynamic thereby serves as a pull factor for additional flows into onshore equities. Moreover, domestic regulatory encouragement for mutual funds and state-owned insurers to increase A-share investments, as highlighted in January’s “five-measure” announcement, also acts as a push factor for flows into the onshore equity market.

Recent policy shifts aimed at supporting domestic consumption, as external demand fades, should foster a broad-based and gradual recovery in sentiment over the medium term, lifting deflationary pressures in the domestic economy. The “anti-involution” policies, which advocate for rational quality competitions over price competitions, will also help ease the downward price cycle. This will promote healthier margins, especially for industries currently experiencing pressured profit margins, such as metals & mining, with industry leaders potentially gaining better pricing power and market revenue share.

Looking ahead to the July Politburo meeting, albeit light market expectations, a continuation or expansion of these supportive measures will be beneficial to equity markets, and any surprise stimulus could serve as an additional tailwind, marking it crucial to monitor policy development.

Investment implications: onshore or offshore? 

From a valuation standpoint, both onshore and offshore equities remain relatively cheap compared to valuations in most developed markets. While the Hang Seng A-H Premium index is trading at 130, nearing pandemic lows and 5% below its 10-year average, this suggests a further relative attractiveness of onshore over offshore shares. There should be more factors to consider when choosing between onshore or offshore equities for investors.

From a portfolio risk perspective, offshore equities typically exhibit lower volatility due to a higher proportion of institutional investors, resulting in a more mature investor base. The sustained low Hong Kong Interbank Offered Rate and solid initial public offering pipeline should also continue to attract global capital inflows and enhance offshore equities’ performance for the rest of the year. Conversely, onshore equities are likely to receive stronger government support during systemic market drawdowns, as evidenced by the stabilization efforts in April.

From an investment return perspective, onshore equities provide access to a deeper market that better reflects the gradual economic recovery ahead while offering a healthy dividend yield. In contrast, offshore shares unlock exposure to the dynamic growth themes in Chinese innovations, such as the artificial intelligence-led rally in February and the emergence of Chinese intellectual properties, as discussed.

Both offshore thematic growth and onshore high yielders have demonstrated robust performances (Exhibit 1 & 2). However, it is important to note that this performance does not extend uniformly across all sectors and industries. Therefore, rather than making a clear-cut decision between offshore and onshore equities, investors could consider adopting a barbell strategy that balances thematic growth leaders with a selection of high-quality high yielders, thereby allowing for the diversification of growth and income opportunities within Chinese equities. 

¹Performances are based on MSCI China sub-indices and are in U.S. dollar total return terms.

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