China's economy is a paradox, say the participants of our investment roundtable. They discuss the mismatch of economic growth and stock market performance, investment opportunities and product trends. Chaired by Stefanie Eschenbacher.
Xiao Feng Zhong, deputy chief executive officer (Amundi Hong Kong)
Alex Ng, chief investment officer, Asia Pacific (BNP Pribas Investment Partners)
Bill Maldonado, chief investment officer, Asia Pacific (HSBC Global Asset Management)
Ting Li, senior managing director, Asia excluding Japan (State Street Global Advisors)
Funds Global: Chinese companies accounted for a third of all global initial public offerings (IPOs) last year and most of this was raised on Chinese exchanges. How easy is it to find investment opportunities in China? Have you become wary after some of the scandals?
Bill Maldonado, chief investment officer, Asia Pacific, HSBC Global Asset Management: Several companies faced fraud allegations last year, something that was widely publicised. This almost created the perception that every Chinese company was a fraud. Those, however, were the exception. Due diligence is as good or as bad as anywhere else when it comes to IPOs. Sometimes it is not entirely clear what is technically a fraud and what is just confusion over local regulation, such as land ownership.
Alex Ng, chief investment officer, Asia Pacific, BNP Paribas Investment Partners: Disclosure standards have been raised in recent times. While we seek for more transparency, we also need to make sure no critical details are buried on page 678 of a prospectus. Investors have learnt that there are neither one-way bets such as Chinese IPOs, which rise on the first day of trading, nor a remninbi that only appreciates in a straight line. This has created a more cautious approach – if not a healthy cynicism – in the market place. Unfortunately, investors do not mature through the textbook; they need to feel the pain. On a more positive note, we have not seen failures in the brokerage sector this time around, compared with the bear market in 2005.
Xiao Feng Zhong, deputy chief executive officer, Amundi Asset Management: Despite some liberalisation of the Chinese equity market, it remains largely closed to external investors. They can invest in China’s A-shares market only through the Qualified Foreign Institutional Investor (QFII) scheme. The market is still maturing and there are fewer investment instruments and products available.
Maldonado: China’s investment landscape is dominated by retail investment managers, who typically do not employ the institutional-type processes we see in Europe or North America. The stock market is often driven by momentum, with investors aiming to identify stocks that will run for the next month.
Ting Li, senior managing director, Asia excluding Japan, State Street Global Advisers: One paradox is that China’s economic growth is not reflected in equity returns. This has become more obvious in the past year than ever before. Many foreign investors who buy Chinese equities look at economic growth numbers. The reality is that there is no link between economic growth and stock market returns.
Maldonado: This is true universally, not just in China. There are, however, few countries where the discrepancy was so large.
Funds Global: China’s economy was growing at double-digit rates but its stock market has underperformed. How do you explain this unusually large discrepancy?
Maldonado: There is neither a theoretical nor an empirical link between economic growth and stock market returns. If anything, they are slightly negatively correlated.
Li: Financial markets are often regarded as a shadow of the real economy. In China, the financial markets’ function is more favourable for raising capital rather than seeking investment return. The IPO mechanism is the first to be blamed for low correlation.
Ng: Looking at year-on-year performance numbers, China’s stock market rose to the top and then fell to the bottom. Over the past five years, it has either topped the list of ‘best’ or ‘worst’ markets to invest.
Li: Though stock market performance in China does not have a correlation with economic growth, there is one between stock market performance and monetary policy. This link is very strong.
Funds Global: Are you worried China’s economy might suffer from the effects of overheating?
Maldonado: The aspiration to own property is rooted in the Chinese culture and exacerbated by a lack of other investment opportunities. The stock market is extremely volatile so ordinary people are reluctant to invest in stocks. Property is a natural choice for them and remains an important asset class. This might lead to asset bubbles in the property market, something that China’s policymakers have realised and tried to deal with.
Ng: The fear of inflation is another factor as many consider property an inflationary hedge. China’s demographics mean that the part of the population that buys homes has been structurally rising, though this will change at some point.
Maldonado: A lot of the funding for property comes through big banks and a few local government vehicles, which are partly financed by these banks. This is not an ideal situation. Instead, China would benefit from better-functioning capital markets for both equities and bonds.
Funds Global: Much of the economic activity in China is unrecorded and the volume of transactions in the shadow banking system remains large. Do you see the government targeting the shadow banking system?
Ng: Small and medium-sized companies have not significantly benefited from state bank loans. Involving second and third-tier banks might bring them into the formal financial system.
Maldonado: China’s policymakers are likely to create broader, better-functioning markets that are more easily accessible to institutional investors. Apart from the property market, I expect more involvement from institutional investors in the petroleum area and banking. The banks are also strictly regulated by the government and they can only lend up to the point where the loan-to-deposit ratio does not exceed a certain threshold. Some of the banks are at or close to those thresholds. The amount of new lending they can do is controlled by government regulation.
Zhong: The five state-owned commercial banks – Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank and Bank of Communications – are likely to remain the dominant players in the market. These banks allow the government to channel resources to the sectors it wants to stimulate.
Li: They are also a policy tool.
Maldonado: And one for control.
Zhong: It is likely the government will encourage some second-tier banks, or even third-tier banks, to get involved. This would reduce the reliance on a few banks and also spread the risk. Third-tier banks, however, have been involved in some scandals because they lack effective control.
Funds Global: China appears to have accelerated its approval process for QFII licences foreigners need to invest in the domestic A-shares market. What are the drivers for opening up the investment quotas and do you see this continuing?
Zhong: When there is a sudden surge on capital inflow, the government will typically slow down the process of issuing QFII licences. Every time liquidity dries up, it will speed up the process. The rules remain the same, but processing time varies. Both QFII licences and qualified domestic institutional investor (QDII) licences, which allow Chinese asset managers to raise funds in China and then invest overseas, are tools to regulate capital flow. Considering the size of the Chinese market, however, these quotas are relatively small.
Li: These quotas will have little, if any, impact on the Chinese market. But they are a good indication of the government’s position on capital flows.
Maldonado: There is a desire to broaden the market and make it more institutional, though this will only happen in a controlled way. There is a much broader range of investors with a QFII quota. I expect a stable increase in quota allocations, involving different types of investors from different countries.
Ng: QFII quotas account for just 1% of China’s stock market capitalisation. However, we should not underestimate the impact on service providers. Today, there is interest in the QFII scheme from sovereign wealth funds, university endowments and foundations. Interest in the scheme has broadened and this means that global investors will bring best practices to the market and its service providers.
Li: When the China Securities Regulatory Commission admits foreign investors into China, this means global institutional investors’ best practices are being introduced into the market.
Zhong: Policymakers in China have always been tactical in the sense that they have managed the process of gradually opening up the financial market, introducing new technologies and management practices.
Funds Global: The offshore renminbi bond market has seen explosive growth. But critics say it is still illiquid, lacks a proper benchmark rate as a reference point for pricing floating rate bonds, as well as a sufficiently developed swap market. What is your stance?
Li: The Asian Bond Fund 2 Initiative, which was launched in 2005, was the first initiative to stimulate the domestic bond markets as a source of long-term funding for Asian borrowers. This fund promoted local currency bonds as a new asset class for both local and foreign investors. It invests in eight local currency bonds – both government and corporate bonds – from China, Korea, Malaysia, Hong Kong, Singapore, Thailand, Indonesia and the Philippines. The China proportion of the portfolio is from those issued in mainland China. Since 2005, China has opened up further, most recently with the development of the dim sum bond market. These are just two steps of the Chinese government’s strategy to liberalise the renminbi.
Maldonado: The dim sum bond market, the offshore market for renminbi bonds, has become an interesting asset class within a short time. It has attracted a wide range of issuers – not only Chinese issuers but also international companies – and buyers. Some of them are AAA-rated and others have no rating at all. The secondary market is still relatively illiquid and can be compared with the high-yield market in Europe or North America. Most investors, including us, will buy dim sum bonds and hold them. The market is not so much about trading or potential gains in the short-term. Investors sometimes forget that fixed income benchmarks are not like equity benchmarks. With the exception of a few illiquid stocks, investors can generally go and buy equity benchmarks. Fixed income benchmarks are different in the sense that there may be bonds nobody has, as in inventory. Investors may not be able to buy these bonds or they will have to pay a high yield premium for these bonds. There has been enough demand for dim sum bonds that issuers could offer 1 to 2% yields and still be able to sell them. The dim sum market is now maturing; it is no longer a frontier market.
Zhong: While growth has been spectacular, the market is growing from a low base. Another important aspect is that its performance has not been correlated to that of the onshore market.
Ng: In the offshore market, issuers can afford to experiment with the high-yield end of the credit spectrum. In the onshore market, on the other hand, the government encourages a corporate bond market of the highest quality.
Funds Global: How do you see the demand for exchange-traded funds (ETFs) and other passive products developing?
Li: When comparing the Asia Pacific region with the rest of the world, its share in the ETF market is relatively small. Growth, however, is significant. Hong Kong has more choice in terms of products, including more synthetic ETFs. In both markets asset managers have an ambition to cross-list their products. The next step for China will be to approve ETFs that link to an overseas index, something we expect to happen this year. Chinese investors often invest in global ETFs through their QDII, a trend that has grown significantly.
Funds Global: How does the demand for physical ETFs compare to that of synthetic ones?
Li: Investors prefer physical ETFs. Synthetic ETFs used to be considered innovative, but the financial crisis has changed this. China does not accommodate derivatives.
Funds Global: Is Hong Kong still the primary market within Asia or has it been overtaken by Chinese exchanges?
Maldonado: Hong Kong is still the primary market in Asia, which is mainly a result of its fully functioning capital market functions, stable regulatory framework and good reputation. International investors acknowledge Hong Kong as a market that can compete with the likes of London and New York. It is also the most dynamic market in Asia.
Li: The linkage with China gives Hong Kong an advantage over other locations.
Ng: Hong Kong has become somewhat of an experimental ground when it comes to innovative products. It is also more sophisticated when it comes to complex financial instruments, such as derivatives. Hong Kong was one of the pioneers in the futures market, although Korea has certainly overtaken it in terms of liquidity and trading volumes.
Funds Global: Were you surprised when an Italian luxury goods company, Prada, decided to list on the Hong Kong stock exchange?
Li: Prada’s was one of the biggest IPOs last year. Hong Kong is an efficient market for companies to raise money and also create value for investors. This is crucial for an international financial centre.
Zhong: For many companies, Hong Kong is about getting exposure to the Chinese consumers. It does not stop at the Chinese consumer, though. Increasingly, natural resources and mining companies list in Hong Kong.
Maldonado: Another trend we have seen is that Chinese companies are pursuing dual listings in China and in Hong Kong. There are about 70 companies with dual listing already.
Funds Global: Do you see demand for sharia-compliant investment products and services from countries such as Malaysia and Indonesia?
Maldonado: HSBC Amanah offers Islamic banking and financial services in both countries.
Ng: We manage shariah products in Indonesia and Malaysia, where we also have a local presence. The Malaysian government has been more proactive in trying to promote this type of investment.
Funds Global: In which of the frontier markets do you find the most compelling investment opportunities? How are you planning to tap into these?
Maldonado: Indonesia is an interesting one, something that everyone who has recently been to Jakarta will appreciate. It does not feel like the capital city of a developing country. But investment opportunities are scarce. International credit ratings agencies have upgraded both Indonesia and the Philippines in recent months. The Philippines used to have a stigma attached to it, but those times are gone. Elsewhere, everybody is excited about Myanmar. The question is how you invest in Myanmar? Buying an apartment in Yangon perhaps, but it is much harder for institutions. Ironically, one of the dangers in such hot markets is the amount of money flowing in.
Ng: Asian markets more generally, whether they are emerging or frontier markets, have increased in depth and breadth. In the past, the Asian investment universe consisted largely of finance, property and utilities. Now there are so many more sectors and investment opportunities to choose from. However, I do share concerns over liquidity, volatility and corporate governance in selected cases.
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