While China’s equities rout in recent years has caused some asset owners to reconsider the nation’s position in their emerging markets portfolios, others are adamant that not investing in China will be a risk in its own right.
The CSI 300 index that tracks listed Shanghai and Shenzhen stocks has slumped since hitting a historical high in 2021. In August 2023, China’s Ministry of Finance made the historical move to cut stamp duty for the first time in 15 years on A-share stock trades.
It propelled a moment of optimism that did not stick. Earlier this year in February, the index hit a five-year low coupled with massive capital outflows as intuitional investors’ confidence waned.
Brighter Super’s head of listed equities and ESG Fiona Mann said that the decline wasn’t a massive surprise, but the fund is keen to see some stability in the market. China accounts for 20 to 30 per cent of the $30 billion fund’s emerging markets portfolio, which itself is about 10 per cent of its global equities portfolio.
“We run a systematic strategy in that market. It’s not active and it’s not passive – it’s kind of in between,” she tells Investment Magazine.
“We have active managers who have the opportunity to invest in China and most of them haven’t at the moment. They are looking, but the problem is they can’t find businesses that they believe are not going to have any impact from the state-owned enterprise system.
“Not expecting surprises is important for us in an emerging market,”
RMB woes
Mann is of the view that there needs to be more large-scale stimulus across the economy before the Chinese market can rebound, but AMP’s head of portfolio management Stuart Eliot says the measure won’t offset the challenges in the long run.
Eliot oversees the portfolio construction and asset allocation for the wealth giant’s $50 billion of super assets. The fund has tended to be underweight emerging markets equities since 2019.
“There are two main drivers to why the Chinese stock market has been weak,” Eliot says.
“And one is that the economy is fundamentally challenged. There’s too much leverage, too much misallocation of capital, and the demographics are shocking.
“The other is there’s a trend globally, particularly in the US – not surprising given how hawkish the US government is in terms of trade with China – that a lot of the fund managers are moving their emerging market allocations to be ex China.”
Eliot says much of the sell-off is not driven by investors taking short positions and betting against China; rather, it is that China no longer makes up part of their investable universe.
“The propensity for a big turnaround is less because you don’t have people who need to cover their short if there is a big stimulus package coming,” he says.
It is going to take some structural changes to pivot towards an open economy for China to restore investor confidence, Eliot says.
“One thing that they could do would be stop artificially propping up the currency,” he says.
The People’s Bank of China has defended the RMB persistently in the past, issuing warnings against bets on its depreciation and fixing the daily reference rate (around which the currency is allowed to trade at plus or minus 2 per cent) at a higher-level last year.
“I think once you actually see a market determined FX price and market determined share price, then you would be more confident in taking a longer-term investment position there,” Eliot says.
China FOMO
However, MLC chief investment officer Dan Farmer has a more positive view. Insignia is still relatively neutral on Chinese equities now, but he says the valuation is “reasonably attractive” and the market is being watched closely.
One of Farmer’s investment team members also travels to China and Taiwan every year to gather insights on the ground.
Farmer, who oversees the management of the bulk of APRA-regulated superannuation money across the various retail funds owned by ASX-listed Insignia Financial, says the firm has come back from that visit with “reasonably constructive feedback that China can deal with its structural problem”.
“It is still clearly a large and growing part of the indices and that will continue, so not investing in China becomes a risk in its own right,” he says.
While US-China geopolitical tension remains concerning, Farmer believes that the two countries “need each other equally as much” in the long term.
“Through time, we’d be expecting those tensions to moderate just through practicalities of the reliance with each other for global trade, and demand for production will ultimately be a stabiliser to some of those tensions through time,” he says.
“We’re always cautious about those risks and try to maintain good liquidity when investing in China.”
Meanwhile, super funds may also have better luck trying to harvest alpha further down the capitalisation spectrum in emerging markets, says Frontier Advisors senior consultant Brad Purkis.
“For example, if you look at emerging markets managers’ top 10 Chinese holdings or top 10 Indian holdings, they look very similar to the top 10 in their respective benchmarks,” Purkis says.
“We’re exploring whether it makes sense for clients to go into single country strategies and have managers that go further down the capitalisation spectrum into the mid and small cap areas of those markets.”
