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On the record: China

We asked two pension funds to tell us about the case for investing in China and their experience with investing in the country

Carsten Warren

Misconceptions about risk

More than 6% of our equities portfolio is invested in China, including Hong Kong shares. We have a dedicated emerging Asia fund as well as several global funds that invest in China and the region. We have also had direct investments in Chinese real estate through funds, primarily shopping malls and residential property. The trend of China opening up its capital markets to western investors will be gradual, partly because the A-Shares market is volatile, due to Chinese retail investors. However, I do expect a deepening of Chinese capital markets. The share of global GDP of the emerging Asia region is high, but the value of its capital markets is relatively low, and this discrepancy will fade as time goes by. We are focused on being a part of that. 

For a number of years our primary emerging Asia fund has focused on large caps. Recently, we have invested in an Asian small cap fund, in order to capture a broader opportunity set and be part of the regional transformation, characterised by the growth of the middle class. We are seeking exposure to a region where demographics and economic growth will be important in the coming years relative to other regions. We are looking at emerging Asia, rather than just China. 

It seems that few of our peers are doing something similar. We have looked for asset managers with strong regional resources, who understand the dynamics of local capital markets. 

Leveraging local expertise is how we mitigate risks. There is a misconception about the level of risk of investing in China, which is not much different from other regions. As with any foreign investments, you have to make the effort to travel there and get to know the people, which we have been doing for years. We feel we now know the region well. 

The need to partner up with local experts explains the emerging market risk premium. We think the premium is still there, as can be seen in valuations, which seem cheaper for similar types of Chinese companies. As a long-term investor, we definitely want to pursue these risk premia. 

When investing in China, we must focus our attention on their awareness of ESG matters, and their interactions and dialogue with their investee companies. There is obviously a lot to do but, again, we are happy to be part of that journey. The Chinese seem focused on raising the environmental standards of their economy, and that should lead to investment opportunities.

patrik jonsson

The thesis still holds

Our main Chinese investment consists of an allocation to A-shares. Last year, we were granted a licence to invest directly in Chinese government bonds and have started running a portfolio internally. We also invest in real estate in partnership with local investors. 

The allocation to Chinese A-shares makes up about 2% of our strategic portfolio. It might not seem much, but it equates to 15% of our allocation to emerging market equities, which is significant. 

We made our first investment in Chinese equities in 2013, but there was a plan to invest in China from 2005. By 2007, the board of AP2 had run an analysis on the topic that reached five conclusions. 

The Chinese economy is still growing exceptionally fast and we cannot see an end to that, despite the slowdown. The economy is undergoing structural changes, with a shift towards domestic consumption and services. Exposure to local equity markets allow us to benefit from that. We see a diversification effect from investing in A-shares. The exposure we get to the renminbi is also beneficial as the currency becomes global. In 2007, we also expected a flow of assets towards China and that it would be advantageous to be at the forefront. 

The problem in 2007 was that valuations were high and the board waited. Then, in 2012, valuations had fallen and we applied for a Qualified Foreign Institutional Investor (QFII) licence. We were surprised how quickly we completed the process. 

The trade tensions between the US and China are a concern, but not just for our Chinese investments. Similarly, the high levels of debt in China are a global phenomenon. Otherwise, the reasons to invest in China in 2013 are still valid.

The board was bold and decided to seek benchmark-agnostic managers that could extract alpha in this inefficient market. We relaxed the limitations mandates further in 2015 and the level of alpha we are achieving is astonishing. We are running an average alpha of more than 1,000bps per year with three different managers. Interestingly, we are not maxing out risk levels compared with the index.

When investing in China, you have to know what you invest in, which is why we partnered up with managers who have local expertise. We work with APS, Cephi and UBS. They have different approaches and perform well for us.

The allocation to Chinese government bonds, which is being managed internally, is 1%. The team is learning how the market works and building confidence before they take higher risks. 

ESG was always a concern to investing in China. When we appointed our managers, we put an emphasis on sustainability. The fact that investments are being done through segregated mandates means we can apply our exclusion list. In 2015, we excluded companies involved in the coal businesses, from miners to utilities. We have been working closely with our managers on responsible investment and demand they report on the ESG standards of every company we invest in. 

It is encouraging to hear that the managers themselves are becoming more engaged. They tell us that our approach is forcing them to raise the bar on ESG and, as a result, the ESG standards of their products are rising. This means they are becoming more appealing to other clients too, which is a win-win for us. 

Interviews by Carlo Svaluto Moreolo

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