This content is from: Portfolio

J.P. Morgan Thinks the Darkest Days for China Have Passed. Allocators Remain Cautious.

Rising sanction risks and a rule requiring foreign fund firms to set up communist party units are giving allocators second thoughts about investments in the country.

The Chinese markets tumbled in April as the Covid lockdown in Shanghai disrupted investors’ confidence and global supply chains. But J.P. Morgan Asset Management believes that’s the bottom – at least for 2022. Allocators, on the other hand, are less optimistic.

“I do think the actual investment outlook for China has improved a lot just over the past month,” Gabriela Santos, managing director at JPMAM, told II in an interview. Santos said there are early signs that the Chinese equity market will begin to rebound. 

One obvious catalyst for the manager is the easing of Covid lockdowns. On June 1, the government lifted the strict lockdown on Shanghai, which disrupted both the local and global economy, prompting foreign businesses to leave for other emerging markets. According to JPMAM’s second quarter report on China, 28 percent of companies have plans to move their production sites out of China in the next three years.

“The first thing we wanted to see was just a better strategy for dealing with the pandemic,” Santos said. “That doesn’t mean abandoning zero-Covid – we don’t think that will happen this year – but just some tweaks at the margin that can decrease the impact [on] the economy.” Such changes include setting up large testing sites and setting a lower threshold for reopening.

China’s own stimulus measures contribute to JPMAM’s confidence. While other major economies have been raising interest rates to curb inflation, China has been easing monetary and fiscal policies to revive its economy. “The pace of that stimulus has really stepped up, [which provides] a good roadmap for corporation and local government as the economy reopens,” according to Santos. In addition, Santos said financial oversight measures, which have upended some sectors including online education and real estate, is entering a new phase where “it’s just more status-quo regulation instead of the introduction of new regulation all the time.”

Not everybody is optimistic. Investors’ mixed sentiment on China is reflected in fund flow data. Many allocators expressed concern about de-globalization and China’s economic outlook.

“There’s certainly a lot more questions [about China] than there have ever been,” said Kevin Edwards, senior investment director at Hartford HealthCare. “We are still exploring because we’ve had the thesis that we think it might make sense from a portfolio construction perspective to have a dedicated China A-share mandate, but we are going to continue to explore and understand the risks we might be taking that are not purely market-driven.” 

One of those is political risk. According to Edwards, Chinese securities are more likely to be sanctioned by the West than other emerging market investments. “China is going its own way and not willing to cut Russia off,” he said, adding that the suspected unethical use of labor in China also adds to a growing sense of unease among investors. Still some geopolitical experts argue that the investment risks from the ties between China and Russia are overstated.

In addition, the newly established rule by the China Securities Regulatory Commission asking all fund firms – regardless of their home countries – to set up communist party units has also raised questions. The extent to which the party units can regulate the funds’ daily activities is still unclear. But according to Edwards, there’s a rising concern that foreign investors may have a harder time divesting from Chinese securities. 

Even though the strict lockdown has been lifted, the zero-Covid policy continues to rattle investors. Doug MacBean, managing director of public and alternative securities at Caltech, told II that the endowment doesn’t have any immediate plan to allocate more capital to the Chinese markets given how the authorities have been dealing with the pandemic. “It’s just a problematic policy that gives us pause when it comes to thinking about incremental capital going there,” he said. 

Caltech, however, hasn’t divested from any of the four managers of its China investments. Three of the managers are based in Hong Kong and one is based in the U.S., according to MacBean. That said, the fact that some investors and banks, including J.P. Morgan, started questioning whether or not certain Chinese securities, including the entire internet sector, were investable or not marks a turning point for the country’s investment outlook, he said.

“It’s always been like, how much China do you want? How are you investing in China? This is the first time I heard [some investors]…taking a hard look at being invested in China,” MacBean said. 

Related Content