October 2015

OPINION: Here come the lawyers

Fiona RintoulOdd, isn’t it, how much faith investors from capitalist countries sometimes have in communist dictatorships? “For some reason, investors think that because it is a planned economy, the government will fix it,” one fund manager confided recently of the rumblings that preceded the recent bubble/crash/correction – call it what you will – in China. The Chinese government wasn’t able to fix it quite, and a hailstorm of consequences rained down. Much of the pain was borne by the Chinese people, or at least those among them who are what Jason Hsu, co-founder of California-based Research Affiliates, calls “naïve investors who did not properly evaluate company fundamentals”. European and US investors were good at issuing see-sawing commentaries on China, but weren’t that heavily committed to the Chinese market – at least, not directly.  “Sentiment about China continues to change dramatically,” says Jan Dehn, head of research at Ashmore Investment Management. “Undoubtedly we will see more shifts in sentiment, because so few investors actually invest in China.” Because the pain of the Chinese bubble was disproportionately borne by naïve retail investors, Hsu suggests that the bubble is not primarily an economic crisis.  ‘It is better understood as a social crisis occasioned by massive wealth redistribution that disfavours average investors,’ he says.  Of course, there are always winners and losers on the stock market, and you could argue this was a lesson naïve Chinese retail investors needed to learn.  But many of the winners were hedge fund managers and traders who, says Hsu, “took profits as the market became more expensive and increasingly speculative” – an outcome somewhat at variance with communist ideology.  “The brutal efficiency of transferring wealth from retail investors into the pockets of hedge funds and iBank proprietary desks is inconsistent with the values of many policymakers who favour economic equality,” says Hsu.  And so, this is a political crisis too – one that is inherent in the Chinese model of a socialist market economy with a shovelful of political repression thrown in. It comes at a time when, according to Dehn, power is slipping away from the executive and legislative branches of government towards the judiciary in emerging markets, including China. In Brazil, Romania and Turkey, judges have launched attacks on business and political figures. “A similar process appears to be underway in Poland,” says Dehn, “and anti-corruption drives are playing an extremely important part in effecting change in China too.” In Dehn’s analysis, these are not random, isolated events. The inspiration for many of the anti-corruption operations in emerging markets is the mani pulite (clean hands) campaign by Italian prosecutors in the 1990s. That they are happening now may be partly due to worsening economic conditions, but they are also a natural part of these markets’ development. “This is the stuff of EM – that is part of development itself, as rising middle classes naturally begin to demand better institutions,” says Dehn. This drive creates a particular problem for China. Economic reform without political reform was always a little bit of an apparatchik’s wet dream. Now China has to decide how to manage its, in many ways, anomalous stock market.  “The issue isn’t just that retail investors tend to be long-term losers in the stock market,” says Hsu. “They also hurt the quality of the market and thus injure the real economy over time.” To intervene or not? Success depends on the quality of the institutions that must now emerge. “Regulation and intervention can only work when policymakers are at least as adept and knowledgeable as market participants, including investment professionals, and when regulators are not in thrall to the industry and populist pressures,” says Hsu. Either way, prepare for change in the Middle Kingdom. Fiona Rintoul is editorial director at Funds Europe ©2015 funds europe

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