It was great to see so many delegates at the Allocate to China event last Thursday—around 140 professionals from asset management and related industries here in London. China capital market does have its gravitational pull! Stephen King’s keynote speech is enormously enjoyable, while the panel discussions also provided such a satisfying feast of thoughts.
The theme of the event is A Reality Check 4 Months after MSCI China A-Shares Inclusion. Just as Robert Parker (Chairman of AIMC at ICAM) put it in his opening remarks at the 2nd penal discussion, a dose of reality that each of us need to have at this time is that China equity market has been down for over 20% since the beginning of the year and Chinese currency is under a lot of depreciation pressure. Nevertheless, we see an increasing number of accounts being opened to allocate to China. It is not because the market timing is good, but because the absolute level of international capital participation in China is just too low and there is only up to go.
Any key findings? There are many! And all-important messages. It is not possible to put them into a couple of paragraphs, so I have done a summary below. If I have to use one sentence to describe the key takeaways, it will be: Allocate to China, Alternatively and ESG-ly. The fact that China is still an emerging market makes it a sweet spot for alpha generation, especially through alternative and private market investment; attention to ESG has quickly picked up in China in the last couple of years and many leading local asset managers have been developing their ESG capability and this has made them more attractive to European institutional investors.
Here is the summary of the findings of the event.
1, Macro prospects of China market:
- China is going through a strategic and structural change from an export-led economy to a domestic consumption focused economy;
- Securitization level in China is still low so there will be higher securitization growth in the next decade, 2-3% higher than GDP growth. This means an increasing number of investable assets in the market.
- US-China trade tension is a major headwind causing uncertainty. Chinese currency under depreciation pressure but competitive depreciation is not what China intends for and not in the interest of China to have market stability. China still has tools to avoid over depreciation.
- The “zero-cost capital” issue (SOEs enjoy low-cost capital while private businesses do not) may cause short-term misprice but in general, consumer-facing industry, healthcare service, technology-based businesses, where private ownership prevails, would have much better performance and presents good investment opportunities.
2, Active/Passive debate in the Chinese market context:
- Generally speaking, China, with a lot of emerging market characteristics, is very much an Alpha play, with stock picking as a sweet spot for the next 10-20 years.
- In the past year, ETF into China grew reasonably but not as large as expected. Growth mostly comes from funds that track MSCI.
- Passive and active products target at different clients. Some investors would use ETF as a first step to get familiar with a new market such as China and then expand to active products when they have more experience.
3, Fixed income market in China
- Global investors participate mainly in China’s government bond and financial institutional bonds (e.g. bond issued by the China Development Bank), very little investment into corporate bonds;
- Major issues in Chinese corporate bond market:
(1) domestic credit rating (usually all AAA or AA) not able to differentiate quality;
(2) prevalence of mis-pricing products: Normal performing bonds are traded tightly due to too much money chasing, while distressed debts offer a generous return. Convertible bond a good example of being under-priced;
(3) no tested cycle for dispute resolution in court yet.
- The private lending market offers good return with a surprisingly low default ratio;
- The bond connect introduced 2017 are making changes to China debt market: international rating agencies now access the market and give ratings to domestic bonds; international investors are reshaping the domestic bond valuation.
4, Alternative assets and private market in China
- Alternatives and private market investment fit in well in China market to generate alpha;
- Big amount of private capital enter consumer-facing, technology and healthcare service sectors, supporting their growth and offering investment opportunities;
- Some big UK institutional investors now invest in private market/alternatives in the developed economy only. But the illiquid premium in a developed market (e.g. UK) is diminishing.
5, ESG in China
- The attention to ESG has pickup-up very quickly in China in the last 12 months, largely due to the push from AMAC;
- Understandably ESG in China have different focus and practice from that in Europe;
- Some leading asset managers in China have started to build up dedicated ESG team and capability;