All China Access

Sally Rose

By

07/06/2018

The establishment OF Shanghai-Hong Kong Stock Connect and Bond Connect, and the inclusion of China A-shares in the MSCI Emerging Markets Index, have provided new opportunities for international investors to access Chinese exposures.

Despite this, and China’s status as the world’s second-largest and fastest growing economy, the nation’s equity and fixed income markets remain underrepresented in the portfolios of many global asset owners.

Increasingly, however, some of the world’s most sophisticated asset owners and managers are moving to add to their direct exposures to China.

With China A-shares’ weighting in the MSCI Emerging Markets Index set to rise gradually, institutional investors around the world have more reason than ever to ensure they understand the market and the role Chinese equities play in their portfolio via indirect exposures.

How Australian institutional investors are approaching Chinese markets was the topic of discussion at a recent investor roundtable hosted by Investment Magazine and sponsored by HSBC Asset Management.

First State Super pioneer

In 2017, First State Super became one of the first Australian institutions to be granted a Renminbi Qualified Foreign Institutional Investor (RQFII) licence by the Chinese Government. This means the fund is permitted to trade directly in the mainland Chinese equity markets.

First State Super senior investment analyst Hui Henry Zhang, who is responsible for overseeing the China exposures in the $85 billion industry fund’s portfolio, said it was strange that most global institutional investors didn’t actively allocate to China.

“We think China can offer something quite different from the rest of the world and has some very good talent,” Zhang said. “Now we have to think more strategically and are spending some time on understanding the emerging markets within it [by sector] and also emerging regions, such as Western China.”

A case for investment

The Future Fund decided a number of years ago that MSCI including China in its emerging market indices would trigger a review of its China exposures.

“We’ve now gone through the beginning of an exhausting exercise where we have sort of made a case for…us to explore further and turn over all the blocks when it comes to A-shares,” Future Fund head of emerging markets Craig Thorburn said. “China is at the centre of my life because it is the leading centre of emerging markets, but quite frankly it is also probably becoming the leading centre of global capital markets, full-stop.”

Over the next three to five years, Thorburn will be focused on helping the Future Fund gain a deeper understanding of how it can access China. “It’s a very volatile market and, as we saw in the crash of 2015, there are some aspects of institutional markets we take for granted in the rest of the world that don’t apply in China, and by that I am referring to the ability of companies to pull the pin…So we remain very cautious,” Thorburn said.

“And up until recently, in a nutshell, we’ve had concerns about it being a Ma-and-Pa retail market.” He notes that more than 86 per cent of China’s mainland sharemarket is owned by retail investors who “like a punt”.

Growing sophistication

Global Asset Management chief investment officer Asia-Pacific, and global CIO equities, Bill Maldonado said that, while it was true that China was historically a retail market, this is changing more than most people outside the country realise.

“The institutionalisation of China is happening and I think is evident in the way corporates are prepared to interact with investors with respect to discussing their business plans and ESG,” Maldonado said. He explained that a growing proportion of Chinese mutual funds, which have traditionally represented groups of retail investors, now have a mix of local and international institutional backers.

Willis Towers Watson senior investment consultant, manager research, Leslie Mao, recently relocated to Sydney after spending 12 years working out of Willis Towers Watson’s Shanghai office leading a team researching Chinese equities. He was one of the advisers to First State Super as it entered the Chinese market.

Mao said he had observed retail Chinese investors become much more sophisticated in recent years. “They care about fundamentals, but they also tend to overreact, which is actually a really nice thing for institutional investors, because it creates buying opportunities. That’s when you tend to get tremendous value on top of the overall marketplace.”

Cbus looks to Asia

Cbus Super senior portfolio manager, equities, Anna Weickart, said the $47 billion industry fund was in the process of doing due diligence as it searches to appoint a manager for a new mandate in Asia ex-Japan equities. The fund already has exposure to some of China’s largest and most successful companies listed in Hong Kong – such as Alibaba and Tencent – via its global fund managers. And as China A-shares are incorporated into the MSCI indices, it will be these types of large-cap companies that are included first, Weickart noted.

“What we’re really looking for is a manager who can give us exposure to China’s domestic growth story…a lot of which will come from the small to mid-cap part of the market, so we are looking to appoint an all-cap mandate.” Weickart said Cbus was still exploring accessing China A-shares directly, further down the track.

“A lot of organisations and fund managers seem to be going the way of using Stock Connect, probably more than a QFII licence, but I suppose we are just a little bit cautious,” she said. “We’ve still got some concerns about how it will function if there is some kind of crisis.”

HSBS’s Maldonado said he understood that the volatility of 2015 was still fresh in investors’ minds but noted that it had also served as a catalyst for major improvements in the way the Chinese sharemarket is regulated. He argued it would be worth it for investors to put the effort into doing the necessary due diligence to invest in China now. “If you wait until the market is fully matured, then it won’t be the kind of alpha market it is today,” he said.

MSCI changes the game

Visiting Sydney from Beijing, MSCI executive director and head of China research, Zhen Wei, said his team worked closely with regulators throughout the three years leading up to the announcement about China A-shares inclusion in the emerging market index. MSCI faces a massive challenge now in implementation. Add too much too soon and it could artificially ramp the market.

Wei said the company is very conscious of that risk and is in discussions with various stakeholders to prevent any market distortions. “It is important to us to make sure that all parties involved understand how this can work and, of course, from the regulators’ perspective, we want to make it a very smooth experience – we don’t want another August of 2015,” he said.

Local presence

The HSBC Jintrust Fund Management Company is a joint venture between HSBC Global Asset Management and a local Chinese funds-management firm. “We are the only truly Chinese asset managers who are managing onshore money for onshore clients and also advising offshore clients,” HSBC Jintrust chief executive Dong Wang said.

The Shanghai-based Wang said he believed the China-A sharemarket would prove more “steady” and “fruitful” than many offshore investors anticipated. He observed that it was difficult for many people not familiar with China to appreciate just how rapidly its capital markets are developing. Wang said the Chinese regulators were “very hands on” and “want to make everything work better”.

He noted that for those investors who spoke the local language, or had access to good interpreters, most information was publicly available or could be requested. MSCI’s decision to include China A-shares signals to the outside world it needs to start doing something about getting an exposure to China, Wang said.

“If one thing is for sure, it is that the market is growing and opening up; it’s coming, and we are just at the very first stage,” Wang said. “China is a very different market…and the transition and growth of the past five years has just been amazing. I don’t think anyone expected that to happen so quickly, so just be patient and watch and learn the market.”

Cautious approach

Frontier Advisors senior consultant Kuek Chyuan (KC) Low said most of the asset consulting firm’s clients were still accessing China via broader emerging-market strategies. “Some clients are now looking for a China-specific strategy, but we are still reviewing the best way to access that,” Low said.

Given the outperformance of the MSCI China Index over the last year, Frontier now has a preference for A-shares in the short term, he added. Low said Frontier remains cautious about the operational, political and economic risks in China, but is heartened that government-led reforms are reducing the  risks in all those areas. MSCI’s Wei noted that the demand for ESG reporting from foreign investors was set to drive positive changes in the Chinese market.

QBE Insurance head of strategy and growth assets, group investments, Andrew Thomas, said it was inevitable that China would play a bigger role in the global insurer’s portfolio in coming years. “We can’t deny the fact that the A-shares market is going to be a dominant force,” Thomas said.

QBE still has shorter-term concerns about transparency and corporate governance standards for A-shares that may force institutional investors to make a trade off between alpha and risk management. However, Maldonado said HSBC believes it has an offering that will keep investors from having to make that compromise.

“We’ve managed to extract very significant alpha that you couldn’t get in other markets, without compromising on portfolio construction, risk metrics or the investment process,” Maldonado said.

Governance risks

Christian Super senior portfolio manager Edwin Lo said the $1.1 billion faith-based super fund had increased its engagement with specialist Asian equity fund managers over the last three years and was now in the process of due diligence for selecting a manager to increase its exposure to Chinese shares.

He is hopeful that a boom in infrastructure spending in China will create “a lot of adjacent growth opportunities”.

Lo said the fund’s relatively small size made it impractical to apply for a QFII licence, and that he saw better opportunities to partner closely with licensed third-party fund managers. Concerns about corporate governance also make direct investing in China A-shares challenging for Christian Super. “As a pioneer in ethical and ESG investing, we are concerned that there may be some risks we need to understand more and manage better,” Lo said.

Participants

KUEK CHYUAN (KC) LOW Senior consultant, Frontier Advisors

EDWIN LO Senior portfolio manager, Christian Super

BILL MALDONADO Chief investment officer Asia-Pacific, and global CIO, equities, HSBC Global Asset Management

LESLIE MAO Senior investment consultant, manager research, Willis Towers Watson

ANDREW THOMAS Head of strategy and growth assets, group investments, QBE Insurance

CRAIG THORBURN Head of emerging markets, Future Fund

DONG WANG Chief executive, HSBC Jintrust Fund Management Company

ZHEN WEI Executive director and head of China research, MSCI

ANNA WEICKART Senior portfolio manager, equities, Cbus Super

HUI HENRY ZHANG Senior investment analyst, First State Super

Chair

Amanda White, Director of institutional content, Conexus Financial

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