A growing list of risks is turning China into a potential quagmire for global investors.
The central question is what could happen in a country willing to go to great lengths to achieve its leader’s goals. Chinese President Xi Jinping’s (習近平) friendship with Russian President Vladimir Putin has made investors more distrustful of China, while a strongman narrative is gaining momentum as the Chinese Communist Party doggedly pursues a “zero COVID-19” strategy and unpredictable campaigns to regulate entire industries.
As a result, some international investors are finding an aggressive allocation to China increasingly unpalatable. Outflows from the country’s stocks, bonds and mutual funds accelerated after Russia’s invasion of Ukraine, while Norway’s US$1.3 trillion sovereign wealth fund has snubbed a Chinese sportswear giant due to concerns about human rights abuses.
US dollar private-equity funds that invest in China raised just US$1.4 billion in the first quarter — the lowest figure since 2018 for the same period, while China’s better-than-expected economic data on Monday prompted questions from analysts who pointed to inconsistencies with alternative statistics that paint a grimmer picture of the economy.
The scale and speed of sanctions imposed on Russia have forced a rethink of Western attitudes to China, said Simon Edelsten, fund manager at British investment firm Artemis Investment Management LLP.
His team at the US$37 billion money manager sold all its China investments last year following Beijing’s interventions in high-profile listings such as Didi Global Inc and Ant Group Co, saying that such moves threatened shareholder rights.
China’s more assertive rhetoric around Hong Kong and sovereignty claims in the South China Sea also made the investment team uneasy, Edelsten said.
“Politics and governance factors should now set a cautious tone, especially for long-term commitments” to China, said Edelsten, adding that European measures taken against Russia show that strong trade ties are no guarantee of diplomatic security.
“The Ukraine invasion raises these risks very sharply and our funds are likely to remain very lowly weighted in China for some years to come,” he said.
Krane Funds Advisors LLC chief investment officer Brendan Ahern said that there has been “indiscriminate and price-insensitive selling” of Chinese shares by international investors in the past year.
Beijing’s regulatory actions “felt like an attack on the most respected and widely foreign-held companies,” while sanctions on Russia raised concern the same could happen to China, he said.
His firm — which manages China-focused exchange-traded funds — is replacing US-listed Chinese stocks with those trading in Hong Kong to reduce risk.
Making money in China’s public markets has become more difficult. The CSI 300 Index of stocks is down about 15 percent so far this year and its risk-adjusted return — as measured by the Sharpe ratio — is among the lowest globally at minus-2.1. That is only slightly better than Sri Lanka’s Colombo All-Share Index.
The Chinese index is trading near the lowest level since 2014 relative to MSCI Inc’s global stock gauge.
For the first time since 2010, Chinese benchmark sovereign 10-year notes offer no carry over comparable US Treasuries, and returns in China’s high-yield US dollar credit market were the worst in at least a decade last quarter.
Global funds have started to pull out, last month selling more than US$7 billion of mainland-listed stocks via exchange links with Hong Kong. They also disposed of US$14 billion in Chinese government debt over the past two months and trimmed their credit holdings.
Betting against China was considered the fifth most-crowded trade in Bank of America Corp’s most recent survey of investors.
“Markets are worried about China’s ties to Russia — it’s scaring investors, and you can see that risk aversion playing out since the start of the invasion,” said Stephen Innes, managing partner at SPI Asset Management. “Everyone was selling China bonds, so we’re glad we didn’t buy any.”
Still, divesting from China might not be a straightforward choice. The world’s second-largest economy possesses a US$21 trillion bond market and equity bourses valued at US$16.4 trillion onshore and in Hong Kong.
Its assets offer diversification for investors, with multi-asset strategies struggling under the threat of inflation and tightening global financial conditions, Amundi Singapore Ltd head of investment Joevin Teo said last week.
Some have even called Chinese assets a haven.
“It’s one of the best diversification stories for global funds because of its idiosyncratic nature,” said Lin Jing Leong, senior emerging market Asia sovereign analyst at Columbia Threadneedle Investments, which manages about US$754 billion.
“Who owns the market, the cycle of China’s growth and inflationary pressures, the low volatility in its currency basket” all help to provide better risk-adjusted returns, she said.
Chinese authorities appear to be taking steps to appeal to global funds.
Regulators last month promised to ensure policies are more transparent and predictable — key sticking points for investors who last year lost trillions of US dollars due to Beijing’s crackdown on tech and tutoring firms.
China is also making compromises that might grant US regulators partial access to audits of US-listed Chinese companies.
While Wall Street giants such as JPMorgan Chase & Co and Goldman Sachs Group Inc are rushing to take full ownership of their China ventures, some companies are divesting.
In March, Germany’s Fraport AG sold its stake in Xian Xianyang International Airport to a local buyer, ending a 14-year stint in China.
The airport operator said it decided to exit the Chinese market after struggling to expand its business.
Fraport also owns a share of Pulkovo Airport in St Petersburg, Russia, which it has been unable to sell.
Others are preparing for China’s decoupling from the West.
Self-driving technology start-up TuSimple Inc is considering spinning its China operations off into a separate entity following US authorities’ concerns over Beijing’s access to its data.
Oil giant CNOOC Ltd might exit operations in Canada, the UK and the US due to concerns that the assets could be subject to sanctions, Reuters reported last week.
Investment professionals at one US private equity fund in Hong Kong are not pursuing opportunities in China as aggressively as before, even though prices are far lower, said a person who asked not to be named as they were discussing internal strategies.
Concerns include the difficulty of exiting investments and problems that could arise from a hardening of positions such as US investment bans or a consumer boycott of made-in-China products.
As risks increase and rewards diminish, adding exposure to China might no longer be a no-brainer for global investors.
In a speech last week, US Secretary of the Treasury Janet Yellen called on Beijing to account for its ever-closer relationship with Moscow.
“The world’s attitude towards China and its willingness to embrace further economic integration may well be affected by China’s reaction to our call for resolute action on Russia,” she said.
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