The potential to earn monster returns on a relatively low-risk consumer-products business such as a liquid detergent makes China irresistible to fundsALY SONG/Reuters
To their credit, every Canadian institution with significant investments in China appears to have avoided the car crash that is real estate developer Evergrande Group .
That’s reassuring, but at the same time, it’s faint praise. Evergrande was an accident waiting to happen, after a debt-fuelled building binge and forays into unrelated fields such as electric vehicles and pro soccer. Short sellers began targeting the company years ago. Investment professionals who failed to steer clear of Evergrande deserve to lose their licences.
The road ahead for investing in Asia in general, and China in particular, will not be as easy to navigate. Growth in the region is expected to slow. In China, the ruling Communist Party is making it clear its political goals drive the agenda, rather than economic expansion.
Evergrande crisis is a global problem, but how big is hard to predict
Two themes emerged from interviews last week with Canadian fund managers and bankers who invest in China; none of who wanted to attach their brands to Evergrande by going on the record. First, they remain committed to increasing Asian exposure, as the region’s growth potential is unmatched. Second, every financial player said as they get bigger in China, they need to get smarter.
To put Evergrande in perspective, several veteran financiers compared the company’s situation to that of Canadian developer Olympia & York, which went bust in the 1990s. In both companies, an entrepreneurial founder rolled out a formula – build big with borrowed money – that worked until it didn’t.
Institutions didn’t stop investing in Canadian and British commercial real estate just because O&Y failed. In fact, fund managers such as Brookfield Asset Management made a fortune from picking up the pieces. Today, no one is going to steer clear of Chinese markets simply because Evergrande is blowing up.
The flaw in this comparison is one of scale. O&Y went down owing approximately $20-billion, much of which was backed by quality properties. Its bankruptcy posed minimal systemic risk. Evergrande owes lenders US$300-billion, and its failure raises the potential for contagion in credit markets. However, in recent weeks, Evergrande shares and bond prices stabilized after steep declines, showing investors are confident Chinese politicians can contain the carnage.
As an aside, despite the torrid pace of economic growth in China, investors made more money owning Canadian commercial real estate over the past two decades. The benchmark MSCI/REALPAC Canada property index posted 10.4-per-cent annual returns since it was launched in 1999. MSCI’s China real estate index, created five years earlier, returned in 9.5 per cent annually.
To understand why institutions remain committed to investing in China, while also building expertise in Asian markets, look no further than the Canada Pension Plan Investment Board. The country’s largest fund manager oversees $520-billion, and allocates $119-billion of the portfolio to Asian investments.
CPPIB, to its credit, tells Canadians a great deal about its performance, including disclosing how much money it gave to external fund managers and what returns they generated. Over the past two decades, CPPIB backed China-focused private equity funds run by Citic Capital, FountainVest and Hillhouse Capital, and returns have been outstanding.
For example, back in 2014, CPPIB committed US$258-million to a fund run by Beijing-based Hillhouse. As of March, that investment had more than tripled in value to US$929-million, as Hillhouse helped launch companies that include China’s top-selling laundry detergent maker, Blue Moon.
The potential to earn monster returns on a relatively low-risk consumer-products business such as a liquid detergent makes China irresistible to funds such as CPPIB and peers such as the Caisse de dépôt et placement du Québec, OMERS and Ontario Teachers’ Pension Plan, which each allocate about 10 per cent of their portfolios to Asia.
However, to navigate an increasingly challenging landscape and avoid the inevitable blow-ups, Canada’s largest pension plans realized years ago they need local intelligence in Asia. CPPIB opened a Hong Kong office in 2008 that is now home to more than 130 employees. OMERS opened an office in Singapore in 2018 and is now expanding the space. Teachers has professionals in Hong Kong and Singapore.
In interviews over the past two years with Asian media outlets, executives at CPPIB, OMERS and Teachers made it clear they were expanding their teams, with an emphasis on hiring experts in credit, real estate, infrastructure and equity markets. Canada’s biggest money managers are scouting for talent in Asia who can find the next Blue Moon, while keeping away from the next Evergrande.
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