Why an active approach to investing in China could potentially reap benefits for long-term investors
China is immense, complex and often opaque. As the second largest economy in the world, professional investors cannot ignore it – but many believe, given its size, an active approach and local presence are crucial to achieving a potentially positive investment return.
This was the view put forward at an event in May, by members of the China Forum – a body founded by AXA Investment Managers and the Clingendael Institute, the Netherlands Institute of International Relations.
Recent times have seen China and the notion of industrial espionage high on the Dutch government’s agenda.
As Frans-Paul van der Putten, senior researcher at Clingendael, put it: “Politics and economics are becoming more and more intertwined. But we shouldn’t see China too much as a threat. We have an interest in China, and as European countries we must enter into a dialogue together.”
The aim of the China Forum is to allow professional investors to exchange knowledge and to develop a joint policy which combines economic interests with societal issues.
AXA IM’s Netherlands head Hanneke Veringa emphasised that the Netherlands is in a position to potentially have an effective influence, by using its considerable pension capital, for instance when it comes to lowering China’s CO2 emissions.
After all, tackling the climate problem effectively is impossible without China’s participation. “Everything depends on what China does,” argued China expert Tim Clissold, author of the book Mr China. The environmental problems are immense, he said, but the approach is also impressive.
He explained: “Think of the enormous effort China is making in the field of solar and wind energy. Renewable energy is already cheaper than coal. High-speed lines connect the country. They are light years ahead. It’s a bumpy road, but it’s a long-term vision that accepts temporary losses.”
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For APG Asset Management CEO Ronald Wuijster, China “is the market of the future”. He explained that the country accounts for 13% of global GDP, more than 30% of global economic growth and 16% of global market cap. The weight in the global indices is just a shadow of that. But he believes that this will change in the coming years, meaning passive investors will also be more exposed to the world’s second largest economy.
If Chinese A shares are fully included in the MSCI Emerging Markets Index, China’s weight in this benchmark increases to more than 40%. However, despite the opening up of the local market to foreign investors, this ‘onshore’ market is not suitable for passive investing, Wuijster stressed. He believes the dominance of private investors leads to a highly volatile market in which speculation and rumours can lead to considerable fluctuations.
But that offers advantages for long-term professional investors. Wuijster explained: “It allows us to buy on the dips. An inefficient market offers more opportunities, and not many markets are as inefficient as those in China.”
Managing and measuring risks
The Chinese local market is also immature in terms of profit forecasts – the final figures differ considerably from the consensus, much more than in the US, for example, noted Wuijster, adding: “So you can make a difference, if you do independent research.”
In China there are potentially significant returns to be made in the area of sustainability in regard to risks and how they are managed, according to Wilco van Heteren, Research Director at Sustainalytics. But mapping this is not an easy task, as less than a quarter of Chinese-listed companies publish a sustainability report – and even then, these reports often fall short, according to Van Heteren.
“Key information is missing. Quantitative data on CO2 emissions, for example, are often not available, and information on more ethical issues is not easily provided either,” he noted.
Sustainalytics makes its analyses based on public information, and then companies are asked for feedback. In China, less than one in 10 firms gives an answer, compared to more than half in Europe, added Van Heteren.
But there is hope. The number of Chinese companies that have signed the UN Principles for Responsible Investing (PRI) is relatively low but is increasing. And Van Heteren is optimistic: “The more foreign capital flows into China, the more likely there will be change.”
At the same time, China’s character is changing enormously, said Mark Hargraves, Head of Global Equities at AXA IM. He said: “As a result of a single child policy, China is facing an enormous ageing population. The labour force is shrinking. The country has been the world’s workplace for 30 years, but labour in Mexico is now cheaper. As a result, China’s competitive position is changing, as is its domestic consumption pattern.”
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For its part AXA IM as an asset manager focuses on numerous dominant themes, such as the Chinese internet revolution and the transition to a more sustainable society. “It’s not just about a cleaner energy supply: rivers are polluted and there’s a shortage of clean water – it’s going to take decades to solve all that, ”added Hargraves.
While China is a state-led economy, with a clear five-year plan, local expertise is crucial for investing in China, Hargraves emphasised.
There can be challenges when the best interests of a company don’t match the government’s overall plan, which can be difficult to grasp in a purely quantitative approach to the Chinese market. Nonetheless for investors, China is “too big to ignore,” Hargraves said. “Opportunities have greatly improved in recent years: there are more private companies than state-owned ones. That increases the potential return.”