Asset managers debate future positioning in China as regulatory crackdown spurs sell-off
Asset managers are debating their levels of exposure to Chinese assets, as a regulatory crackdown across multiple industries in the country dampens investor sentiment.
A torrent of regulatory actions have hit major tech firms, property companies, and video game makers in China, as the government pursues a policy of ensuring the “common prosperity” of its people.
Investor sentiment toward China has plummeted. According to data from Refinitiv Lipper, China-focused equity funds have suffered two consecutive months of outflows, with USD392 million being withdrawn from these funds in August.
Furthermore, in the year to the end of August, China-focused equity index MSCI China has lost 12 per cent of its value. In that time, the broad global equity index MSCI ACWI has notched up returns of 16 per cent.
Ark Invest is one of a number of investors that has “dramatically reduced” its positioning in China in recent months, in response to recent regulatory changes imposed on the country’s education sector.
In July, the Chinese government banned for-profit tutoring of school subjects, as part of an ongoing crackdown on the technology and gaming sectors.
Ark Invest’s CEO Cathie Wood told institutional asset managers that the fund is now only invested in Chinese firms that are actively “currying favour” with Beijing.
Another asset manager, Aubrey Capital Management slashed its exposure to China over fears that the government's new policies would “undermine certain business models”. The asset manager cut its positioning in China from 55 per cent at the start of the year, to just over 30 per cent.
However, the USD1.6 billion Edinburgh-based asset manager is now “scrutinising the opportunities increasingly positively” based on the recent price crash.
“Sentiment still gusts to the negative but there are signs of a price level being reached in some of these stocks with attractive valuations for investors willing to look beyond the short term,” says Mark Martyrossian, CEO of Aubrey Capital Management.
Meanwhile, Invesco said that recent regulatory moves “do not affect our general views on China exposure” with regard to fixed income.
“We do not believe these risks signal a change in China’s policy, which relaxed investment restrictions to allow for greater foreign access to fixed income,” says Wim Vandenhoeck, senior portfolio manager of Invesco Fixed Income. “Nonetheless, we are cognisant that the intensity of the regulatory tightening has raised concerns about investability.”
Willis Towers Watson believes that at a strategic level, the case for including Chinese assets in a global portfolio “remains very strong”.
Last year, the investment consultant recommended that investors increase their China exposure, suggesting a long-term target allocation of 20 per cent.
“We do not believe that these developments constitute an inflection point in China's decades-long programme of economic reform and opening up,” says Liang Yin, Willis Towers Watson’s China project lead.
“What is happening here is that fundamentally, China is pivoting its economic philosophy from basic growth at all costs to a more inclusive and long-term sustainable model.”
For experienced China investors, regulatory crackdowns are nothing new, says Liang.
China has gone through multiple rounds of “regulatory reset” over the past decade, from a corruption crackdown which impacted the high-end dining sector to the government’s centralised bulk drug-procurement programme to cut the cost of medicines.
“If you talk to those people who have spent decades investing in China, it's not surprising at all,” says Liang.
“We spoke to a private equity manager just recently, and they had looked at a potential deal in the private tutoring sector two years ago and walked away because they didn't think the price offered reflected the regulatory risk involved. So, it was kind of evident two years ago.”
Regulators are now targeting internet companies with anti-trust, cybersecurity, data privacy regulations, as well as closing regulatory loopholes for fintech firms in order to protect the banking system, and pushing through education sector reforms.
The direction of travel is “very similar” to that of Western countries, says Liang.
What is different is Chinese regulators’ ability to act. “There's no denying that we are observing some of the most forceful actions by any regulators in the world here at a pace that’s probably almost unheard of to investors based in the West,” says Liang.
Recent actions by regulators show the Chinese government is “prepared to tolerate some short-term economic pain” in pursuit of long-term economic sustainability and resilience.
Willis Towers Watson currently manages USD170 billion of delegated assets, with over USD2 trillion in assets under advisory.
“At the very least, investors should avoid businesses that stand in the way of achieving these objectives, but this is fundamentally not that different to the ESG developments in the West,” says Liang.
Certain pockets of the healthcare sector are best avoided, says Liang, as the procurement reform makes selling generic drugs “pretty unattractive from an investment perspective”.
“There are areas and sectors where the alignment with the state is just much stronger,” says Liang. “I think one notable example is the climate solutions space.”
President Xi Jinping notably pledged that his country would achieve carbon neutrality before 2060 at the United Nations General Assembly last year.
“China faces an enormous task of transforming the world's second largest economy to be net carbon neutral by 2060, and it's our belief that it simply cannot achieve its goal without developing and scaling climate solution technologies,” says Liang.
Artificial intelligence, advanced manufacturing robotics and semiconductors are also sectors in which the Chinese government has outlined strategic plans to invest.
Overall, foreign ownership of Chinese assets is still low. According to a survey by Greenwich Associates in 2019, the average pension fund or endowment has between 3 and 5 per cent allocation to China, with European asset owners typically having less exposure than those in North America.
“China is the world's second largest economy, and many economists believe that it will overtake the US as the largest economy in the world within the next 10 to 15 years. You would have thought that many investors would have a sizeable exposure to this emerging superpower. The reality is they don't,” says Liang.
China has both the second largest equity and bond markets in the world, with combined market cap of Chinese companies coming in at over USD15 trillion. Liang notes that China accounts for only 5 per cent of MSCI ACWI, compared with a nearly 60 per cent exposure to US.
A trade “decoupling” between US and China increases the argument for including direct China exposure in portfolios, he adds.
“The question I pose to clients and institutional investors when first I speak to them is: are you comfortable with holding that very Western world-centric portfolio going into the next decade – when it's not guaranteed, but it's certainly possible, that a big shift of power is happening?”