An engine of world growth for 20 years, the largest consumer of commodities and the world’s No. 2 economy has somehow slipped into “alternative investment” buckets for many global investors.
China’s property bust and increasingly interventionist government, along with deepening geopolitical fissures with the United States, have dramatically dimmed its allure as a destination for international capital.
China may not yet be “uninvestable,” as U.S. Commerce Secretary Gina Raimondo suggested U.S. companies believe, but many investors are recategorizing their reduced exposure – in some cases to alternative investment.
“Alts” are typically assets outside the traditional stocks, bonds and cash buckets, such as hedge funds, real estate and private equity. They are often riskier but potentially more lucrative bets, and are attractive for their diversification and hedging qualities.
Crucially, they are non-correlated with traditional assets. This is where many investors see Chinese stocks and bonds now – a non-correlated, idiosyncratic play, effectively a hedge against their core bets.
That was the anecdotal evidence garnered from investors, asset managers and allocators on the sidelines of the recent “Hedge Fund Week” conferences in Miami. It is also supported by global capital flows trends.
One fund manager said he may put 5 per cent to 10 per cent of his portfolio in Chinese stocks but is fully prepared to lose it. A hedge-fund manager overseeing billions of dollars of assets said he likes China’s “idiosyncrasies” and diversification qualities but noted that his investors’ money is mostly offshore, not onshore.
Alex Lennard, fund manager at Ruffer, acknowledged the economic climate in China is “clearly awful” but his firm is putting money there, essentially as a hedge.
“It’s a small part of our portfolio, about 4 per cent, but it does provide an offset to some of the other market ‘certainties’ that exist,” Mr. Lennard said.
It’s worth noting that they are relative optimists on China. The wider consensus is far gloomier.
According to Morningstar Direct, U.S. equity funds’ average asset-weighted exposure to Chinese stocks in December last year was 1.38 per cent, down from 2.17 per cent three years earlier, while their average equal-weighted exposure is down to 3.5 per cent from 4.13 per cent.
U.S. emerging market funds’ allocation to China as a share of total EM exposure declined to 20.6 per cent from 28.6 per cent on an asset-weighted basis, and to 20 per cent from 26 per cent on an equal-weighted basis.
It is a similar pattern across global emerging market funds. The China portion as a share of their overall EM equity allocation has fallen to 19.5 per cent from 27.1 per cent on an asset-weighted basis and to 21 per cent from 25.5 per cent on an equal-weighted basis, according to Morningstar Data.
Demand for Chinese bonds should be stronger, though, right?
China is included in the US$1.2-trillion benchmark JP Morgan EMBI Global Diversified bond index, and there is now an in-built demand for Chinese bonds from the yuan’s emergence in recent years as an alternative international reserve currency.
But China’s share of the US$12-trillion global FX reserves pie has slipped to a four-year low of 2.37 per cent, and has never been higher than 2.83 per cent, according to the International Monetary Fund.
Figures from the Institute of International Finance show outflows from Chinese debt portfolios for seven straight months and only three monthly inflows in the past two years.
Emerging market ex-China debt funds, meanwhile, have attracted inflows for the past seven months and in January drew in US$47.3-billion, the most since October, 2022, and one of the highest on record.
Whichever way you slice it, investors of all stripes are taking chips off the Chinese table.
This is not how many thought it would pan out.
A Greenwich Associates survey of institutional money managers in 2020 showed that pension funds and endowments had 3-per-cent to 5-per-cent allocations to China and only 5 per cent of North American institutions had any dedicated exposure to Chinese stocks.
Nearly a quarter of respondents said they planned to increase or significantly increase their dedicated allocation to Chinese equities in the next three to five years.
Liang Yin, investment director at Willis Towers Watson, wrote in November that year that investors should consider raising their allocation to China to around 20 per cent over the next decade.
But Beijing’s closer alignment with Moscow, fraying relations with Washington, and a strengthening interventionist hand in business and markets at home have scared a lot of horses.
The findings of a recent survey by the Official Monetary and Financial Institutions Forum of 22 public pension and sovereign wealth funds managing US$4.3-trillion in assets were startling – not one had a positive outlook for China’s economy or saw higher relative returns there.
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