(Bloomberg) -- Two global funds long cautious about Chinese equities have turned bullish, the latest indication of recovering investor confidence in the world’s second-largest stock market.

Norway-based Skagen AS and its US counterpart Boston Partners have both turned overweight shares listed in mainland China and Hong Kong in recent months, citing cheap valuations, significantly priced-in financial and regulatory risks, and improved earnings as key reasons.

The newfound optimism among the two funds and major peers from abrdn plc to M&G Investment Management raises hope that Chinese stocks’ latest impressive rally may have legs. It’s also a sign that global investors may be increasingly convinced of Beijing’s resolve to end a $7 trillion rout and authorities’ restrained approach to reviving growth, as more economic green shoots emerge.

Investors are demanding higher compensation for holding Chinese stocks due to the economy’s structural challenges, but the stance is also driven by “flows, fears and misunderstandings,” said Fredrik Bjelland, portfolio manager of the $1.4 billion Skagen Kon-Tiki emerging-market fund. “And if you can buy when those cyclical drivers are at the most extreme, you will do that.”

Skagen increased the share of mainland Chinese and Hong Kong stocks to 32% of its emerging-market portfolio as of the end of February, from 28% in September and above the MSCI Emerging Markets Index’s 26%. It was only the second time in the fund’s 22-year history that it went overweight on China, Bjelland said.

The fund beat 87% of its peers in 2023 and 91% of them so far this year, respectively, Bloomberg-compiled data show. Its biggest holding is oil giant CNOOC Ltd., whose Shanghai-listed shares hit a record high earlier this month after authorities urged state-owned firms to boost shareholder value. 

“There is no doubt that being overweight China is harder for most people than it has ever been,” Bjelland said. But with many of investors’ worst fears now played out and Chinese stocks trading at depressed valuation multiples, “the incremental risk surely is lower,” he added.

Earnings Bet

The CSI 300 Index of mainland Chinese stocks has risen 5% this year, after slumping 11% last year and becoming one of the world’s worst-performing major gauges. The rebound has come as global investors are set to become net buyers of onshore equities via a trading link with Hong Kong for a second consecutive month, a feat last seen in June and July.

Among such investors is Boston Partners, whose holdings of mainland Chinese and Hong Kong equities rose to 47.5% of its emerging-market portfolio at the end of February, double the level six months earlier, according to David Kim, who manages about $180 million of assets at the firm. His long-only Boston Partners Emerging Markets Fund beat 85% of peers last year.

Kim said he has been adding to e-commerce giant JD.com Inc., citing positive earnings momentum despite a forward price-to-earnings ratio of less than 10 times. He also took a bet on Longfor Group Holdings Ltd., saying the developer’s non-residential properties were undervalued.

“We were seeing pockets of strength in earnings reports,” Kim said. With valuations coming down for the entire Chinese stock universe, that makes firms with stronger business fundamentals look attractive, he added.

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