Since Russia invaded Ukraine, investors have been rethinking China. The result? A lot of opinions.
In fact, some of the most influential asset managers remain optimistic about China, even as big allocators continue to pull back amid geopolitical tensions, politics, and the country’s zero Covid policy.
The polarizing sentiments on China investments are reflected in the fund flow data. In the last week of February, net inflows into Chinese equity funds dropped to $890 million from $1.2 billion a week before as investors started to evaluate whether Western sanctions on Russia might be extended to China, according to data that EPFR pulled for II. From there, funds climbed back up until the stream reversed into outflows of $3.6 billion as China announced the city-wide lockdown of Shanghai after a surge in Covid cases. Then, during the last week of April, net inflows dramatically increased to $4.5 billion after China ended the controversial regulatory clampdown of the country’s technology and property sectors.
Institutions were the primary driver of the fund flow volatility, according to EPFR, demonstrating just how sensitive China investors are to broad macroeconomic shocks. On top of the real economic risks, there are also allocators taking a tough China stance for political reasons. In early April, the $250 billion public retirement system Florida State Board of Administration announced that it had stopped funding new investment strategies in China after Governor Ron DeSantis considered how to move away from countries that are “hostile to American interests.” Earlier this year, the Yale endowment was pressured to investigate its China holdings over potential human rights concerns, according to the Yale Daily News. The West Virginia State Treasury also stopped partnering with BlackRock for its stance on China and climate risks.
But for China optimists, the market still offers vast opportunities despite all the headwinds.
For one, investment professionals with geopolitical expertise argue that the west is unlikely to sanction China as it did Russia. “I think it’s important to draw the distinction between what’s happened with Russia and what might happen with China,” said Andy Rothman, chief investment strategist at Matthews International Capital Management and a former foreign service officer at the U.S. Department of State. “[China] has not criticized Putin the way that some western countries have, but I don’t think the U.S. or E.U. will put sanctions on China just for that.”
Rothman added that China is only at risk of Western sanctions if it were to violate the U.S. and E.U. restrictions on Russia. “There’s no evidence [China has] done that, and I don’t think [it] will do,” he said.
Siguo Chen, portfolio manager at RBC Global Asset Management (Asia), agrees that China is unlikely to make aggressive geopolitical moves that would trigger the same vehement responses from the West. “China is a much bigger, much more integrated economy than Russia,” she said, adding that the conservative Chinese leadership should “provide some comfort” to investors seeking stability.
China’s response to Covid is another key concern for investors. Since early March, a new wave of Covid has swept Shanghai, where over 25 million people have been subject to strict lockdown rules. Many investors worry the continuing zero-Covid policy would disrupt global supply chains and slow down China’s economic growth, which is already facing a severe demographic challenge.
Rothman acknowledged that China has made a mistake by locking down Shanghai, but said the Chinese government is usually “pragmatic and realistic” about fixing policy implementation mistakes. In addition, he said that compared to the early days of the pandemic, China now has a better public health playbook to follow. “Back in the early days, we just didn’t understand the science,” he said.
Ferrill Roll, chief investment officer at Harding Loevner, warns investors against knee-jerk reactions to public health crises in emerging markets, especially China. During the SARS outbreak in 2003, Harding Loevner pulled money quickly away from Hong Kong, only to find that three out of the four companies it divested from did extremely well in the next 18 months. Having learned the lesson, the company kept its investments in China when the coronavirus hit Wuhan in early 2020. That decision paid off, he said, as the Chinese equity markets offered huge gains in 2021.
Roll added that there still are attractive investment opportunities in China and the broader emerging markets. “There are lots of high-quality growth businesses in healthcare, technology, consumer discretionary, and communication services sectors, which include all the search engine, internet, and the entertainment companies,” he said.
The presence of retail investors is another plus for institutions. Unlike in the U.S., where institutional investors dominate, a large retail investor base in China offers up a lot of mis-pricing opportunities.
Ginny Chong, head of Chinese equities at asset manager Mondrian, said that most retail investors in the onshore China market are not driven by fundamental factors. They tend to trade in high velocity, which often drives stock prices to extreme high or low points, offering up stocks at a discount to watchful investors.
There’s “more trading than investing” in an inefficient market like China, which is good news for more resourceful institutional investors, said Jason Hsu, founder and chairman of Rayliant Global Advisors. The best approach to a retail-dominated market is to adopt what Hsu calls a “quantamental” approach, which is mix of fundamental and quantitative methods.
With Chinese equity markets dipping into bear market territory, Hsu is pragmatic about the risks — at least in the short term. “If you ask [whether] China is worth investing, I’d say it’s certainly a better investment today than it was a year ago,” he said.