Magazine issues » October 2020

Roundtable: All investment roads lead to China

Funds Europe hosts a 360-degree investor view on increasing ease of access to the world’s second-largest economy, splitting China off from other emerging markets, tail risks and what a US-China-fuelled global technology bifurcation means. Chaired by Romil Patel. Armit Bhambra (director, head of UK asset owners, BlackRock, iShares)
Daniel Booth (chief investment officer, Border to Coast)
Simon Kellaway (regional head of securities services for Greater China and North Asia, Standard Chartered)
Amandeep Shihn (head of emerging markets equity and sustainable investment manager research, Willis Towers Watson) Funds Europe – Which sectors, themes and asset classes in China are you optimistic about from an investment/distribution perspective over the coming 12 to 18 months and why? Armit Bhambra, BlackRock – When we think about China, we think first and foremost about the strategic case. As it grows in importance and the nexus of global growth shifts towards the East, the strategic case for China is strong, and that is true of both equities and bonds. China is the second-largest economy in the world, it has got the second-largest equity and bond markets globally, and yet it’s only 3% owned by foreign investors. Those numbers don’t really stack up, so from a neutral strategic asset allocation perspective, China is broadly under-owned.  For the near-term case and looking out over next 12 to 18 months, we are more cautious. We like China, but markets have come quite far quite quickly, having bottomed out a couple of months ago post-coronavirus. Whilst China is emerging well economically and has managed to avoid a second wave whilst the rest of the world battles with containing the virus – we’re starting to see that come through in the economic data – China is trying to balance growth with financial stability more than ever, and that has led to a more muted policy response than some other countries. In the very near term, a return to US-China trade tensions will be coming through, so there are a few things on the horizon to be cautious about over the next 12 months, which is explained by a number of different factors, but that sits in the context of us being constructive for lots of different types of investors that China should be part of the portfolio.  Simon Kellaway, Standard Chartered – Although we have seen a significant increase in terms of foreign institutional investor allocations to Chinese equities, the overwhelming focus appears to have been on fixed income asset classes over the past year or so. Everybody is familiar with the increasing asset allocation to Chinese securities as a result of index inclusion changes across both equities and fixed income; in itself, this has been driving up levels of participation in China exposure from overseas investors. In terms of the perspective of relative positioning of yield from fixed income assets, Chinese government bonds are performing particularly well, and that gives them an additional edge to those that need to allocate towards fixed income asset classes when comparing them to Western government debt securities, where yields have collapsed over the past few months. The relaxation of inflationary threshold policies that have recently been announced at the central bankers’ Jackson Hole meeting goes a long way in helping to reinforce the likely longer-term disparity between Chinese fixed income yields versus their Western equivalents (even when FX conversion costs are taken into consideration). These two key factors will help to ensure continued foreign investor interest in direct Chinese fixed income assets in the short to medium-term. From an equity perspective, there is also an increasing focus on technology and technology-related stocks. This is not limited to China, but is a global phenomenon, particularly when it comes to online commerce. Our everyday lives have been radically impacted by the pandemic – and one key market segment where this is evident is within the online world. Lockdown restrictions have fuelled dramatic increases in online commerce which has positively impacted many high-profile Chinese technology stocks. Enforced home-based leisure time has also increased individual gaming activity, which has made equity stocks that are focused on this area more appealing. The rise of home working, which is less prevalent in China now but continues to persist in other countries, particularly in Europe and the US, has helped to drive market valuations in video-conferencing platforms and cloud software providers, many of which have Chinese origins. Standard Chartered recently conducted a China investor sentiment survey with Funds Europe and interestingly, about 16% of respondents were interested in pursuing the private markets in China; which has been a challenging segment until recently. Daniel Booth, Border to Coast – Time is an important perspective. If you look back 500 years, China and India were dominant global economies and the US has come from nowhere over the last 150 to 200 years. So, emerging economies are a perspective and China and India are re-emerging economies who are reclaiming their place in the world order. China is further advanced than India, but they are going in the same direction. I have invested in onshore Chinese markets since 2005. Following poor performance in onshore markets in 2004, you then had the following two years with 100%-plus returns for the A-shares market. Border to Coast sees China as a strategically important market, which is why we have split China out from the rest of the emerging markets in our recent public procurement. We think this will be a future trend, so we want to be positioned ahead of that. So, both the increasing index allocations, you’ve seen in the FTSE emerging markets go from 35% to 45% China allocation over the last year, as well as the probability that China will be reclassified and taken out of emerging markets – we are trying to position ahead of that. China is also an interesting market to play active management, there is evidence of higher alpha in China versus other parts of emerging markets, so it’s a great market for active management where there is not a lot of institutionalised investment processes and therefore a good area to play from both a strategic as well as an active point of view. If you look at the longer-term – five to ten years – Chinese equities are still trading at slight discounts compared to US equities, so the long-term valuation metrics. The fixed income markets will benefit from the downward pressure on rates from an ageing demographic, which ages drastically over the next ten years. Long-duration Chinese bonds will likely converge toward developed market rates and therefore offer pretty good value, and equities will benefit from investor flows. Amandeep Shihn, Willis Towers Watson – Over the long-term, there is great benefit from allocating capital to China. The moves to make it easier to invest in onshore assets by the government has spurred that on. It’s not as if China has been absolutely closed off from investment in the past, we have had clients allocating to domestic Chinese equities in the past, it’s just a lot easier now as investors no longer have to go through the process of getting QFII and RQFII quotas to trade. It’s important to make the distinction that China has not all of a sudden become investable – the frictions for trading and investing in the market have just come down. Over the long-term we do want access to China – it is under-represented in global markets and we have got a separate allocation to China alongside our emerging markets allocation in terms of our strategic overview. While the weight of Chinese assets in the emerging markets index has increased to a dominant position, we have not broken China out from emerging markets, but investors on average tend to be underweight domestic Chinese assets, and so it makes sense at this stage to have a separate China allocation. We haven’t broken China out from emerging markets because it’s still classified as an emerging market country, in the same way that if we’re looking at global markets, the US is still a very dominant part of global equity markets, and we don’t necessarily break out US from global and manage a global ex-US plus US developed equity portfolio, not as standard anyway. We prefer investors to utilise their broadest opportunity sets. With China, we see this as the all-China universe rather than just domestic China, because there are dual listings. It’s prudent, in our opinion, to allow fund managers to be able to allocate and make valuation calls between listings for the same company that might be on both exchanges, so all-China gives you the broadest possible opportunity set to leverage that view. We are positive over the long-term, and it seems strange that when you think about the two global superpowers, the US in global portfolios has a weight of 50% and China only about 5%. That’s a large imbalance, particularly when you see that there are more companies in the Fortune 500 list of companies domiciled in mainland China and Hong Kong than in the USA. So, there’s a large skew in how assets are allocated. We are positive on wanting exposure to fixed income markets, but we have struggled to find what we believe to be attractive net-of-fee proposition offerings in government bonds, preferring instead to access markets via currency and interest rate mandates. Booth – What do my colleagues think about the potential development of twin structures of the IT infrastructure – if China and the US separate and we get two systems, what are the risks and opportunities from that? There’s a risk that we get different internet infrastructure, so there’s a lot of tension between the US and China, and a lot of the emerging markets are coming into the China sphere of influence. There are various restrictions going on – the build-out of 5G and so forth, so how might that develop and what are the potential opportunities and risks? Bhambra – When we think about tensions around the trade war, we see them being played out around technology, and we have seen it with Huawei and the experience of 5G more locally here in Europe. It is going to be interesting, given how quickly China seems to be able to produce new technologies. We see the Chinese tech sector as disrupting itself, it is creating technologies for itself that the rest of the world is looking to and looking at how it can adopt. This going to be a central point of tension between US and China when thinking about investment strategy going forward. Bearing in mind this tension, and that US and Chinese tech tends to operate in different spheres, there are opportunities here to own both regional sectors without a large amount of overlap. Kellaway – To a certain extent, we believe that there’ll be an increase in technology bifurcation between China and the West. You have to put this bifurcation into context – the sheer size of the Chinese market is staggering. For example, the population of China is 1.4 billion people and of those, 890 million are active WeChat users – that’s 64%. That’s a huge critical mass that helps to inform not only the global adoption of this technology, but also its continued development.  Shihn – There has generally been a misrepresentation and a misunderstanding of emerging markets, and I include China in this, as always being copiers and followers of what happens in developed markets. In actuality, what you see is because some of the legacy infrastructure isn’t there, there is greater ability to leapfrog and create newer technology and solutions. WeChat, for example has greater functionality than WhatsApp; it’s unfair to characterise everything as having to have come from a developed market world where everyone else follows. We see that in parts of Africa as well – the mobile payments systems, people don’t necessarily go to bank branches, instead they use mobile payment systems. We’re still getting there in the UK and the US.

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