Chinese Alternative Investments: Important Source of Alpha

Chinese alternative investment can provide strong alpha generation opportunities for global investors yet there are also a few challenges ahead. Richard Johnston of Albourne Partners talks about the pros and cons of China’s alternative investments.

24 August 2020

Chinese alternative investments (hedge funds plus private market investments) have proved to be a strong alpha generator and caught increasing attention from global investors. Yet the manager selection, due diligence, and ongoing monitoring is no light job at all. Richard Johnston, Partner and Head of Asia for Albourne Partners, the alternative investment advisory firm for global institutional investors, talked about their extensive coverage of Chinese long-short, long-only, and private equity managers over the years. He shared his observation about the improvement on investment and operational sides that Chinese managers have made, but also pointed out the regulatory and structural issues that still exist. But his key message is that the Chinese alternative market has been such an important source of alpha and it remains to be underweighted by global investors.

Richard Johnston, Partner and Head of Asia for Albourne Partners

In general, I would say China is a source of so many alphas and I think it’s really hard to overlook it.

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Q: What is your observation over the years on the improvement that Chinese alternative managers have made in various aspects that made them more investable for global investors?

  • Chinese managers start to move from short-term to long-term investors;
  • The level of transparent communication with investors as a manager has been improved a lot.
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Q: What are the weaknesses that Chinese alternative asset managers still have and how should global investors deal with these issues?

  • Infrastructure is always one of the issues:
    • If you set up an investment team in China, you need an off-shore entity to be your regulated entity which increases complexity.
    • The different culture of regulation: China regulation is product-based, to deal with the investors, you always need the regulatory environment based on activity which creates infrastructure issues.
    • Infrastructure governance and independent oversight of Chinese asset managers are weak.
  • To solve the issue, investors can encourage managers to address these issues, set up goals, or milestones to improve the infrastructure.
    • Feedback and fixing things are important parts of the process.

Q: Do you see increasing allocation to Chinese alternative managers in recent years by global investors? Is that increase fast enough? What sorts of sectors are attractive for global investors?

  • We are seeing a lot of interests in allocation to China which attracted by very high alpha coming from China in a lot of strategies;
  • But the increase is not fast enough: China is a significant component of the world, but the global indices are way behind.
  • China’s allocation varies in global portfolios. Most of the global investors are structurally underweight China.
  • China has been a big alpha source:
    • The median return for Chinese medium long-short managers is 7.8% and for long-bias or long-only managers is 14.5% at the end of June.
    • The median of 3-year alpha for Chinese long-short managers is 8.2% and for long-bias or long-only managers is 5.7%.
    • In addition to equity, credit markets, especially the high yield market, property market, private credit, and private equity market also have opportunities.

Q: Has the pandemic or geo-political tension affected the global allocation to Chinese alternative and how?

  • The biggest near-term impact of the pandemic is the inability to travel: It is a challenge mainly for new managers because it’s harder to build trust through video than face-to-face.
  • I haven’t been so aware of the pressure against allocation to China that comes from geopolitical tension, but I am a bit worried about that.

Q: Have you covered the ESG aspect in your assessment of Chinese alternative managers and what is your comment on this with Chinese managers?

  • Governance has been the core focus of ESG consideration for asset managers in China, to avoid companies that run for “alternative agendas ”.
  • The quality of company management, especially their ability to reinvest profit, is also a big consideration for asset managers.
  • “E” and “S” are less focused: Investors focus less on capital investing businesses which are driven by government agenda but focus more on the private sector in consumer-facing businesses which is not the risky area of “E” and “S”.
  • We are seeing much more ESG practice in a long-only strategy but hedge funds are picking up.
  • We have a survey for managers to track and understand their ESG policy and procedures, but we have not scored them yet.
  • Globally Europe is leading the ESG In North America, we are seeing the pressure towards other issues (e.g. minority, women-owned businesses and diversity, and inclusion).

Q: Would you like to talk about any other initiatives or topics on China’s alternative investments?

  • I am involved in the Asian chapter of SBAI which is the standard of alternative investments, I certainly encourage asset managers to understand these standards;
  • We also set up China working group:
    • There is a paper that helps to identify the differences between onshore fund structure and offshore fund structure;
    • The paper is a good template for onshore managers who want to go offshore.
  • The development of different China market reforms is also a critical topic:
    • The real liberalization of the stock loan market will be a big development for the scale of the industry;
    • We are expecting much more access to the China bond market because we see a lot of opportunities. Reducing access limitations on the repo market could help create a new range of strategies.
  • Every liberalization would bring a whole new range of strategies and potential capacity for alternative investments.

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