China is now the world’s second largest equity market, and investors are turning to dedicated China equity strategies rather than relying purely on emerging market funds for their exposure according to Robert Doyle, director of public markets – equity at bfinance.
Speaking on Market Narratives, a podcast series hosted by Investment Magazine’s head of institutional content Alex Proimos, Doyle said as many as “three in four institutional investors achieve their China equity exposure through emerging market equity strategies, which typically have a 25-40 per cent allocation to China”.
To listen to the full interview with Robert Doyle on the Market Narratives podcast click above or find the series and episode on Apple Podcasts, Google Podcasts or Spotify.
Offshore and onshore
Relatively few EM equity managers have significant experience investing in the onshore China ‘A-Shares’ market – which, until just a few years ago, was largely inaccessible to most overseas investors. Today, China specific equity strategies are now becoming common.
Doyle said that EM equity managers have ‘tended to focus their attention on the more accessible offshore market of Hong-Kong listed ‘H-shares’ and US-listed ADRs, creating a bias towards better-known large and mega-cap companies and leaving A-Shares under-represented’.
He also added that the growing prominence of A-Shares in global indices – and the sheer breadth of the market – is leading to demand for experienced specialist investors to manage this increasingly significant part of a global equity portfolio.
As asset owners decide upon implementing a dedicated China exposure, could consider three strategy types: A-Shares, offshore-focused and ‘All Shares’. A-Shares strategies are the likely port of call for investors who wish to access China via their EM equity exposure, given the relatively limited overlap between these two mandates and an abundance of products with “reliable medium-to-long term track records,” Doyle said.
Offshore strategies – the longest-running type of China strategy – appear to offer limited appeal in today’s environment, providing little-to-no exposure to the more sought-after domestic market.
It is in the nascent All Shares category where we see particularly exciting growth in terms of the number and credibility of strategies, with their ‘go anywhere’ approach allowing managers to allocate across all types of Chinese equities and capitalise on structural inefficiencies. Doyle explained that “the growth of this segment will likely be accompanied by an expansion of ‘EM ex-China’ strategies, allowing asset owners to implement entirely separate allocations to China versus other emerging markets”.
Contrasting local boutiques and global asset managers
From a performance perspective, active Chinese equity strategies have demonstrated alpha generation, particularly in onshore markets. The average A-shares manager, for example, has delivered more than 10 per cent p.a. outperformance vs benchmark over the last five years.
The Chinese market is vast and, outside of the large-cap space, there is very little (in most cases, zero) sell-side analyst coverage. With 70-80 per cent of all Chinese equity trading conducted by retail investors, there is a short-term mindset whereby investment decisions (and therefore share prices) are driven more by sentiment and news flow than underlying company fundamentals. The Chinese market has clearly proven to be an ideal hunting ground for institutional-minded, long-term stock-pickers.
Doyle also discussed that there is no discernible performance differential between the average ‘local’ manager versus the average ‘global’ asset manager. He said ‘with global asset managers similarly represented by experienced, ‘on-the-ground’ investment teams, there is no obvious competitive edge that favours one type of firm over another.’ This has proven reassuring (particularly from an operational due diligence perspective) to those asset owners allocating to China, allowing them to invest with firms with which they may already be familiar.
Historically, ESG considerations have represented a major challenge when investing in Chinese equities. However, Doyle sees this changing. The inclusion of China A-Shares in major global indices has brought a new wave of overseas investors to the market, many of whom adhere to their own ESG policies and practices. Chinese companies have taken note of the needs of their international shareholders, and disclosure around individual E, S and G aspects appears to be improving. From 2020, all listed Chinese companies are required to produce ESG reports.