The economic rise is entrenched. Next comes China’s financial rise – but many Western investors are still not exposed to it. Funds Europe speaks with investment experts – including TfL Pension Fund and fund managers in Asia.
Funds Europe: Overall, are you optimistic or pessimistic about the investment/distribution landscape in China?
Don Amstad, Aberdeen Standard Investments – I’m in the glass half full camp. It would be naïve to think that China is without challenges, of course there are tremendous challenges there, as there are in all countries or in all investment destinations. China’s challenges are different, but the starting point for most people is very different, whereas most global portfolios have very substantial exposures to the developed world and the Western world relative to China’s role in the global economy, many people are dramatically underinvested.
The biggest mistake is to underestimate the pace of change in China. It’s fair to say that the starting point is low on average, and very low in many cases, but improvement is real. What is interesting is this: China is not a democracy, so everything that’s good that happens is because of the Communist Party and everything that’s bad is because of the Communist Party, there’s no-one else to blame. It’s not like in the UK where we flip-flop between Labour and Conservative governments and the first thing that a new government comes in and does is blame the past government for all the problems that they have to face in their first 100 days. In China you cannot pass the buck, it stops with the Communist Party.
With technology everyone in China can see the lifestyles that people lead in New York, London, Paris, Singapore or wherever and they want that lifestyle now. Many have moved into the middle classes, and the key is China’s ability to shift from a focus on the quantity of economic growth to the quality of economic growth. China lives by the mantra of social stability, and they understand that social stability can only happen if you have economic stability, and you can only have economic stability if you have financial stability. The last 40 years have been about China’s economic rise, but the next 40 years are going to be about China’s financial rise, and people who underestimated China’s economic rise need to be very careful not to underestimate China’s financial rise.
Simon Kellaway, Standard Chartered – Broadly speaking we’re optimistic and confident about the investment landscape in China over the next few years, but we’re also positive regarding the longer-term as well. The only difference that I would say about this year, and the next few years, is that compared to past activity we will be talking not only about inbound investment but also about outbound flows. There’s a plethora of structural reforms that the Chinese are either implementing, or are in the process of finalising, that are aimed at easing not only inbound capital flows but also outbound investment flows.
Now, I don’t for one-minute feel that the Chinese Communist Party wants to give up total control of all inbound activity, so for example, the concept of a true nominee account structure, will no doubt come with some caveats. However, this general relaxation of access restrictions does mean that international investors can focus more on the fundamentals and can make decisions around the specific investments that they want to pursue. We’ve touched a little bit upon some of the private markets as well as some of the public markets, and hence rather than unnecessarily getting tied up with infrastructure and financial plumbing issues regarding whether they have the license to investment in specific asset classes or whether they have enough quota, international investors can start to focus more on their internal investment processes, consistent with other overseas financial markets.
Overall, this is a journey that will only, in my view, increase individual and institutional investors’ asset allocation towards China. It’s about identifying value right now as well as potential future value, and I think that there will be a continuing shift more towards active investment rather than more of the same passive capital allocation.
China is a market that no investor can afford to ignore, and we will see slowly, through a variety of different schemes, an increased participation in both the fixed income market and the equity markets. The one caveat is that we still have a fair way to go in terms of bringing international standards to some of the structural activities that China has to offer. On the concept of increased allocations towards some of the private markets, investing in some of these markets is really about caveat emptor – being very thoughtful about where you’re allocating capital, who you’re allocating it to, and how the assets are both held and reported. Transparency is key, yet there is still some way to go before the local private markets achieve a parity with accepted European standards.
Active investment management by foreign players will also bring an increasing focus towards what is often termed ‘international standards’. Even within the local public mutual funds market there are increasing calls for true segregation between asset managers themselves publishing fund valuations versus independent third parties, and retail distributors who are also being appointed as local custodians. Whilst we don’t believe that there will be an immediate drive for the full outsourcing of both middle and back office activities, as we have seen in the West (the current economics aren’t forcing this approach in China due to local infrastructure efficiencies and broadly common technology infrastructure), there is a slow, but growing focus on greater transparency and more segregation of duties. In our view, anything that helps to further support investor confidence in the local asset management industry and to attract increasing numbers of foreign players, from both a capital flow as well as an local manufacturing perspective, will ultimately be hugely beneficial to the entire Chinese asset management industry.
Padmesh Shukla, TfL Pension Fund – I am very optimistic about China as an economic opportunity for a variety of reasons ranging from a clear long-term economic vision, ability to plan for long-term, higher productivity trends, innovation and growing internal market.
Vision is only as good as its delivery. You need the right ingredients to actually deliver a vision, and that’s where China stands out with a high-quality workforce, world-class infrastructure and vastly improved health and educational outcomes for its population. The country has managed to pull 800 million people out of poverty – something that’s very easy to forget.
The Chinese are some of the most entrepreneurial people, and it’s very easy to discount that. You can look into studies, not only in China itself, if you look around the Asian bloc, most of the business leaders and entrepreneurs are ethnic Chinese. So, there is that culture of dynamism, innovation and risk-taking.
Allocation to China in a typical pension portfolio today is in single digits, whereas if one takes the marginal economic growth impact of China and related Asian bloc on global GDP, it would be as high as 60%. If I take the population and size of the economies on a PPP basis, the share would be in the high 40’s. So, clearly there’s a mismatch between asset allocation and the size of the Chinese footprint.
You have to think about risk as much as about the opportunity. It is fair to remark that decision-making has been centralised under the current Chinese leadership, with the power increased centralised into a few hands and committees. It’s too big and complex a country for central planning as we know where these things end if the government begins to micromanage. China has done well on the back of private entrepreneurs and my fear is this trend towards over-centralisation and government interference may be hugely detrimental to this spirit of entrepreneurship. It’s not there now but you can sense things going in that direction and that’s my main long-term fear for China.
Nikesh Patel, Kempen Capital Management – I’m optimistic about the prospects for China in our portfolios over the short-term because we are exposed to onshore China, but I’m pretty pessimistic that most institutional investors in the UK or the West in general will benefit from China meaningfully over the next 10 years. I think most investors are going to miss out on the opportunity, and I don’t think the Chinese market will be sufficiently open and welcoming to Western standards to make it mainstream in time; I don’t think onshore China will become mainstream until the 2030s.
I would also split the view into the investment case and the distribution case. The investment case is strong; the distribution case is also looking pretty strong. When we did our analysis of the Chinese active manager market, more than 90% – in some cases 98% – of active managers outperformed the benchmark, and almost all the managers that outperformed over three years also outperformed over five years. That’s a great distribution story. Indeed, it’s a suspicious distribution story in terms of the numbers, indicating a very poor-quality benchmark. But in order to get real scale of distribution you have to be able to pass due diligence of Western institutions. We can’t just say because they have performed well that we can wave them through the level of due diligence these investors are accustomed to.
The investment case is strong in part because there’s a huge under-allocation to China in both global equity and global fixed income, and particularly for the onshore China market. A lot of people talk about Chinese exposure, and they are aware of their exposure to China, but it’s really offshore China, and that’s not where the real opportunity is.
I’d also further temper that investment case with the debate we had on ESG, which will play deeply on the concerns of institutional asset owners. The fact that there is a perception gap is part of the issue, but frankly perception is reality, particularly when you’re talking about boards of trustees and pension fund managers on matters of ESG. We have to explain to our boards and our members, and if the perception of China is that it is a poor scoring ESG country, the investment case is almost irrelevant. This is the same argument we’ve had with poor scoring Western industries, you can’t just keep saying: ‘Well, I’m going to ignore it because the perception is wrong.’ Perception does matter.
So, whilst I’m optimistic about the investment opportunity, and I think there will be a few others like us who will be early adopters and benefit from it, I think it will be the mid-2030s before we see China becoming a mainstream distribution market.
Dong Wang, HSBC Jintrust – I’m optimistic about China’s pace in the next three to five years. I was born in Shanghai, I spent my entire life in Shanghai, so I bear witness to the fantastic change over the last four-and-a-half decades, so I have every confidence in terms of the way forward.
China is opening up so all those asset managers can set up fully owned subsidiaries in China. Having more participation from the outside world is welcomed, so that will make the market more efficient.
In 2021, the first year of the 14th five-year plan, the political will of the Communist Party to really change to a more high-quality path is quite apparent. They have the political will to get this done, so at this moment in time, the Communist Party has improved their overall support among 1.4 billion people and have done a number of things quite right – Covid-19 has been a recent one, and also when they set out the target to remove extreme poverty back in 2012 when Xi first came to power. That wins support from the Chinese people in terms of lots of those remote areas after all those years finally are out abject poverty. Also, the overall anti-corruption campaign in China over the last eight years since Xi came to power won a lot of support.
The Chinese people’s overall support of the party has been the strongest in recent history, which feeds into the overall will to execute a lot of plans such as zero carbon by 2060, urbanisation and a greener economy. If you have the political will from top down and you have the support from bottom up in terms of this large population base, that will bring in the overall materialisation of all these good things. Then looking back 15 years down the road, that will have been a very good journey in terms of furthering the goodwill to China as well as to the entire world. That’s where I think the overall economy will be more sustainable and that will have a more positive impact outside of China. That market will also recognise the overall quality of the growth rather than in the past where it was more about the quantity growth of China.
*This discussion formed part of the wider discussion for Funds Europe’s China roundtable. You can access a free advance copy of the China Report here.
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