Funds Europe – In terms of ease of access when it comes to China, how easy it is for investors to access the market and which routes stand out?
We are just about to launch a China mandate and go public with the selection of Chinese managers that we have undertaken. One of the big questions was: ‘Can we actually implement an all-China strategy using the Hong Kong Connect, and how much of the universe do we miss out?’ What we found is that the big liquid stocks are comfortable using the Hong Kong Connect, so we haven’t had any pushback from the credible large managers as part of that selection process, including the ones that we selected. That makes it a lot easier for us than having to go through the old route of QFII licences.
Stock Connect has definitely made investing in onshore China a lot easier, it’s reduced those frictions for trading dramatically. There is still an advantage for investors who can trade A-Shares directly, utilising quotas and local licences, because the investment opportunity set is still so much broader than it is via Stock Connect.
An interesting perception here is what you see with respect to some transaction costs on some of our exchange traded funds (ETFs). If you go back to when some of BlackRock’s iShares products were relying on the QFII and RQFII quotas, what you would have found was that the transaction costs were significantly higher for investors versus now being on the Stock Connect programme. So, the way that investors are using these types of products has also changed. It was very difficult for an investor to use a China ETF using the RQFII or QFII quotas when the transaction costs were 100 basis points or north of 100 basis points. Acting tactically when the frictional costs were so high was challenging, whereas now on the Stock Connect programme, those costs have come down a quarter or a fifth of the original costs, and so now we’re seeing that investor behaviour is being permitted in different ways because of the way that China has opened it up from an access perspective.
From a mechanical perspective, going back to our recent China investor sentiment survey, 42% of respondents said that ease of access was positively influencing them in terms of capital allocation and further investment into China. Since the beginning of January, we have seen a significant increase in terms of the use of the Hong Kong Connect schemes to access China securities: in July, Bond Connect saw 75.5 billion of RMB (€9.33 billion) inflow, which was a new monthly record.
From our perspective, while we obviously do not see the entire market, we have a sizeable share of both the Bond Connect and the Stock Connect access channels. Recent regulatory liberalisations coupled with relative investment opportunities has resulted in explosive growth in our Bond Connect AUC, up 63% since January. Associated transaction volumes are up 132% and we’ve experienced a 25% increase in terms of active client accounts.
For Stock Connect, whilst the numbers are slightly less, and probably due to both the relative investment positioning of equities as well as the lack of ability to use this channel to access all local market underlying equities, they have still been impressive. AUC is up from the beginning of January by about 50% and transaction volumes up by 31%. So, although there has been quite a lot of work by the regulators to try and ease access through some of the traditional QFII and RQFII routes, the Connect programmes, broadly speaking, still offer easier and quicker access to China exposure. Today, we are looking at getting a Bond Connect account up and running in two to three weeks, whereas at the beginning of the year this could have taken up to two months. Now less documentation is required and hence access is easier, so there’s been a positive real immediate impact in terms of the recent liberalisation measures.
One of the areas which still needs some work is the ability to short stocks for efficient market-pricing purposes in China. That’s not necessarily just for international investors but for all market participants to care about, if one believes that shorting stocks can lead to more efficient markets or a more efficient price-setting mechanism.
Kellaway – Unfortunately, some of the recent events here in north Asia suggest that is probably not going to happen soon. Korea has recently extended its short-selling ban by a further six months. Taiwan originally banned short-selling for six months at the start of the pandemic-induced volatility, but this ban has now lapsed and shorting securities has been permitted again.
Funds Europe – In terms of doing business in China in the securities sector, what types of investor protections exist? How do they work?
That’s an interesting perspective, because you start touching really upon some of the aspects of efficient investing such as transparency and openness in terms of the ability to really dig into companies’ financial positions and accounting reports in a clearer and cleaner fashion. I would broadly state that the investor protections in some investment sub-segments boil down to caveat emptor. It’s not a completely opaque market, certainly not in a way that it was originally perceived when it first opened to professional institutional investors, or when QFII was first established many years ago. It’s a market that has become a lot more transparent in terms of publishing clear company financials – if you are looking for a public listing, particularly in the US, then financial transparency is a critical prerequisite.
Along with the fallout from the passing of the National Security Act in Hong Kong, so the pressure for large Chinese companies to increasingly use the Hong Kong SAR as an international financial conduit to gain access to international capital, rather than New York, is on the rise. In this regard, Hong Kong’s stellar financial reputation, the solidity of its regime, it’s deep liquidity and the confidence that international investors have in its legal structure all play a major part in the attractiveness of the territory for international listings. Locally onshore, it’s a slightly different matter and there are many underlying issues that institutional investors need to be thoughtful of when venturing into this area.
Funds Europe – While tensions between the US and China have risen, financial integration between the world’s two largest economies has actually deepened due to increasing economic liberalisation from Beijing. Do you think the bark is greater than the bite, given that the inflows into China have risen despite the trade tensions and the pandemic, or do you expect greater decoupling from China?
The Chinese and US economies benefit from the crisis because of the flight to safety from elsewhere. I would emphasise the point about the danger that we are going to create two different internet infrastructures with China and the US and having separate worlds with different countries and regions in different spheres of influence. This is a real risk and could have some profound implications.
We are becoming increasingly bifurcated, with the US and China at different poles. This is here to stay and has been accelerated by the pandemic. This bifurcation creates opportunity, though, and increases the need to view China as an allocation in and of itself in portfolios. It’s a rivalry that will be played out in many different areas, such as technology. Another observation is how other countries will have to choose who they play with and how that’s going to play out on a global stage. Again, that may well be through technology, but the shift in power is unrelenting. Going back to 1990, 60% of global GDP was accounted for by three regions: North America, Europe and Japan. Today, Asia ex-Japan accounts for more than those three put together, it’s nearly 40%, whereas those three regions are now under 40%, and that is travelling in one direction. How the interactions between these two big players play out over time, where they play out and how other countries interact to that will really define capital flow for a while. It’s fair to say the tables are turning, if not already turned.
Many regard the US pulling out of the Trans-Pacific Partnership as a big strategic mistake because it pushed the rest of Asia into China’s sphere of influence. That is going to have profound long-term consequences. The amount of interregional trade in Asia has exploded over the last five years, so it’s now a self-contained regional powerhouse in itself.
Capital flows and how countries deal with China and the US is going to shape the recipients or providers of those capital flows and who they go to for their debt and infrastructure development. This is going to have a huge implication on how those economies function. You’ve seen that in some frontier and emerging markets, and even some developed markets where there is a large amount of indebtedness to China. This is a change in the balance of power from countries being backed by typically US-denominated debt. What the long-term implications will be remains to be seen, because these are complex adaptive systems and markets and political regimes will continue to change.
In the long-term, we could look at there being five likely potential global scenarios: globalisation in a world of US-led unipolarity; globalisation in a world of China-led unipolarity; globalisation in a multi-polar world; regionalisation in a multi-polar world; and an end to globalisation in a multi-polar world.
Since the dawn of time, we’ve seen empires rise and fall. The question is, how long is your time horizon? Over the next decade or so, it would be reasonable to expect regionalisation to share the map of influence around a multi-polar geopolitical order led by both the US and China.
Funds Europe – Are you optimistic or pessimistic about the investment/distribution landscape in China?
We are optimistic. China is underrepresented in investor portfolios by an order of magnitude far greater than one would expect, given the scale of market opportunity and its global influence, even considering recent trade tensions between China and the US – with typical investor portfolio exposure to China being around 5%, compared to around 50% for the US. The opening up and reforms of Chinese capital markets are expected to continue over the next decade. That should allow global investors to become more knowledgeable and more comfortable when it comes to owning Chinese assets. There will be challenges and as with any journey, it will not be plain sailing, but we remain optimistic and think the time to start building up knowledge of the market and portfolio exposure is now.
Optimistic over the medium-term, which would be five to ten years, and cautiously optimistic over the longer-term because they do have some challenges to deal with. The biggest one is the demographic transition and how that plays out.
I am optimistic. In the long-term, what we are seeing is a once-in-a-generation, even potentially longer, change in global power and capital, and investors have got a fantastic opportunity in front of them now across both equities and bonds for China, not just for the return story, but also diversification. This long-term optimism is slightly tempered by very real structural risks, namely the deterioration of US-China relations. While this environment may have indirectly contributed to the opportunity in China, it remains a significant tail risk.
We are cautiously optimistic. We are continuing as an institution to invest heavily in the China market, both from a resources perspective as well as a capital standpoint. We do believe that opportunities are there in the medium-term. Just think about the numbers, in particular the emergence of the middle class – there are 400 million in that category alone, which is a greater population than the whole of the US and almost the same as the EU. There’s been a huge rise in GDP, and a proven ability to harness technology in the way that has demonstrated that the increasing focus of the Chinese is not solely on efficient replication but also on progressive innovation. It’s a market that no investor can afford to ignore.
This article first appeared in the Funds Europe China Report.
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