With access to onshore Chinese securities easier than ever before, investors are considering how best include the country into their existing portfolios.
After several years of continual liberalisation, foreign investors now enjoy an unprecedented level of access to China’s financial markets. The list of ongoing reforms and initiatives keeps on growing – Stock Connect and Bond Connect, the inclusion of Chinese onshore securities into international indices, as well as the internalization of the renminbi. All of these developments have helped quickly turn what was a once a niche market for specialists into a major focus for investors across the world.
Now that access is less of an issue, global investors are considering how best to allocate capital into the world’s second largest economy. This topic was discussed by a panel of international fund managers at HSBC’s annual China conference. Representing the entire spectrum of asset management, from pension money to hedge funds, they examined a broad selection of topics related to fitting China into a broader portfolio.
Long-term opportunities in onshore China
The Canada Pension Plan Investment Board is one investor that already has big plans for China. It sees investing in the country playing an important role in meeting its mandate – to maximise returns without undue risk of loss for the 20 million Canadian contributors and beneficiaries.
“We believe very strongly that that over the long horizon over which we are charged to invest, doing so without a significant investment in China would be impossible,” said Geoffrey Rubin, Senior Managing Director and Chief Investment Strategist CPP Investment Board.
Mr. Rubin foresees China having a growing presence in the CPP Investment Board’s global portfolio – from the 10 per cent share it currently takes in the USD392 billion it currently has under management to 17 per cent over the coming years. That would mark a shift from just under USD40 billion invested in China to approximately USD66 billion in both public and private assets, internally and externally managed.
The CPP Investment Board has taken part in many of the channels that foreign investors can use to access onshore China, and Mr. Rubin said that it would be able to meet its allocation targets without further liberalisation. But at the same time CPP Investment Board’s increased exposure depends on certain standards staying in place. “The kind of information that could give us pause are issues around rule of law, corporate governance, and a change in the economic paradigm that exists in China,” he said.
Ease of access is only part of the motivation driving investors to China. It remains one of the world’s fastest growing economies, with a range of investment opportunities that are hard to find in other markets. In many parts of the world, bonds are unattractive, especially government bonds, said Bill Maldonado, Chief Investment Officer Asia Pacific and Global Chief Investment Officer for Equities at HSBC Global Asset Management.
“We are therefore forced to look more at equities,” he said. “To find value, profitability and growth you are drawn to China, which presents very interesting opportunities in the current investment landscape.” In particular, he pointed to the abundance of so-called “New Economy” stocks that are unavailable in offshore markets, in sectors such as healthcare, tourism and consumption. “Over the long run, this is what is interesting in the A share market.”
Managing near-term risks
Despite recognising the long-term opportunities presented by Chinese onshore securities, investors are also paying close attention to both international and domestic developments that are shaping the immediate environment.
On the international front, tensions between the world’s two largest economies dominate the news flow, and the panel discussed how the trade war between China and the US will drive markets over the short term. They also talked about how each incremental tariff imposed will have a smaller impact on sentiment, with the focus shifting to domestic concerns.
One of the biggest developments so far this year is the apparent weakness in the debt market, with the scale of defaults in the first four months of 2019 surpassing the amount seen in the entirety of 20181.
“You have to be very selective in the Chinese bond market, especially in the onshore space,” said Sean Taylor, Chief Investment Officer and Head of Emerging Market Equities at DWS. But instead of interpreting rising defaults as a negative trend, it makes is a sign that the Chinese debt market is maturing by allowing for credit events to occur. Furthermore, it is a boon for investors.
“It is a good sign, because before there was very little differentiation between the pricing of credits,” said Mr. Taylor. “We need that differentiation, as it creates opportunities to generate alpha.”
The rise of bad debt throws into question China’s domestic ratings agencies, which have traditionally given the highest ratings to the vast majority of onshore credits. Investors should not however, see the local rating system as inherently flawed, said Mr. Maldonado, but rather a different system that needs to be reconciled with global standards.
Some investors will therefore only consider trading Chinese bonds that are dual rated – one from a local ratings agency, and another from an international firm. “This approach significantly reduces the investable universe to a pool that consists of mainly financials and policy banks, and we would suggest that it is not really accessing the opportunities that onshore China has to offer,” said Mr. Maldonado. “To do so, you have to further and deeper into the market, and be prepared to get your hands dirty.”