After more formally splitting out emerging markets from its global equities portfolio, Cbus is now considering whether it would benefit from a larger tilt towards Asia, which could incorporate a dedicated China exposure.
Cbus is taking an increasingly specialised approach to international equities and is currently considering whether a dedicated China allocation is warranted as part of a higher overweight to Asian emerging markets, after embarking on an exercise to more formally split out emerging markets from its broader international equities portfolio in 2016.
At that time, the now nearly $68 billion fund for the construction sector implemented an Asia ex-Japan mandate within its EM exposure, but it is now considering the potential merits of a more focused Asian and even Chinese equities exposure.
“We’re looking at China more broadly and that could be China A [shares], or MSCI China All Shares within listed equities.” Anna Weickart, Senior Portfolio Manager for Equities at Cbus, said in an interview with [i3] Insights.
“There is no doubt of China’s significance from an economic, geopolitical and investment market perspective. It is continuing to open up and to liberalise its capital markets, so there could be merits in potentially adding a dedicated China exposure, particularly as China’s exposure in the MSCI Emerging Market index continues to grow,” Weickart says.
It is still early days, however, and a lot more work needs to be done to fully understand the risks and reward opportunities particularly in the current geopolitical environment and regulatory environment.
We're looking at China more broadly and that could be China A [shares], or MSCI China All Shares within listed equities
As index providers such as MSCI have started to increase the weight of China in their various indices, the need for asset owners to increase their exposure to the country is becoming more pressing.
This also needs to be balanced, however, against the potential for South Korea and/or Taiwan to be moved from the MSCI Emerging Markets Index to the MSCI World Index. This would act to offset the increased weight of Asia in the MSCI Emerging Markets Index resulting from China’s increased weight.
Weickart points out that any China exposure needs to be assessed from a total risk adjusted return perspective to make sure investors are adequately rewarded for the additional risk being taken, as well as from a net of fees perspective, particularly as some active onshore Chinese equity managers still charge quite high fees compared to what the fund is used to in other markets. Management fees are often over 1 percent and in some cases even at hedge fund fee levels.
“Alpha potential is high [in China], but you need to be careful about fees,” Weickart says. “A couple of years ago local Chinese managers were marketing in Australia and some of the managers were charging a performance fee that was above cash. This is not something you generally see in the long only equity space!”
“We are considering putting our toe in the water to get a feel for some of these managers, as the lead time to get to know and really understand onshore Chinese managers in particular [could be quite long]. It is going to take a while to develop relationships and so it is something that we are looking at in anticipation that Chinese equities exposure within the MSCI Emerging Markets index will continue to grow”.
Splitting out Emerging Markets
In 2016, Cbus decided to more formally split out emerging markets from its international equities portfolio. At the time, as part of that decision, a formal strategy review was conducted for the emerging markets as a stand-alone sector.
The decision to split out the emerging markets sector from the global equities sector (benchmarked to MSCI ACWI) was to ensure greater clarity in the decision-making process regarding the emerging markets strategy and strategic allocation.
“As a result of more formally separating emerging markets in a standalone asset class, we have a clearer focus on emerging markets with separate investment and risk objectives and fee budget. This also allows for separate managing and monitoring at the sector level,” she said.
“As emerging markets have become more mainstream, we have been able to reduce our fee budget over the years, which is positive for our members, but is still slightly higher than global equities.”
As emerging markets have become more mainstream, we have been able to reduce our fee budget over the years, which is positive for our members, but is still slightly higher than global equities
Cbus has an alpha objective of 1.8 per cent per annum over rolling five years, net of fees, for its emerging market allocation. “That is a pretty high hurdle, but that is [only] slightly higher than for our global equities sector and we believe is achievable over the long term,” Weickart says.
“The new sector strategy aims to be balanced relative to the benchmark, which is the MSCI Emerging Markets index, without any unintended factor, style or risk exposures. Manager, region and sector exposures are also monitored to ensure risks remain within expected parameters, while taking into account the future evolution of the benchmark and expected growth in Cbus assets under management,” Weickart says.
At the time of the strategy review, the portfolio was quite underweight value and momentum, two factors that had shown to work well in emerging markets so the addition of a systematic value momentum manager was proposed.
The strategy was structured to be more oriented towards the domestic demand growth story in emerging markets, particularly in the Asian region and the recommendation was also made to have a dedicated Asia ex-Japan exposure.
The investment team received approval from the Investment Committee and set out to appoint an Asian ex-Japan manager, as well as adding benchmark agnostic, thematic managers to complement the core manager exposure and to better exploit the investment inefficiencies within emerging markets.
Cbus appointed Comgest Far East as its dedicated Asia ex-Japan manager. As of 30 June last year, Comgest managed about $440 million for the fund.
“At the time, we wanted to increase our exposure to Asia (which had been underweight) and gain greater exposure to the mid and small caps,” Weickart says of the decision. “There are some developed markets, including Singapore and Hong Kong, within this index but many of the companies that are listed on these markets do generate a significant portion of their underlying growth from the Asian region, and from China in particular.
“The MSCI Asia ex-Japan index has a higher exposure to China and Hong Kong now compared to four years ago, when we first started on this journey and it has a higher exposure than the MSCI Emerging Markets Index given the relative growth we have seen in China,” Weickart says.
Currently, China makes up 34 per cent of the MSCI Emerging Markets index, while in the MSCI Asia Ex-Japan index, the exposure to China and Hong Kong is nearly 48 per cent.
“For this particular mandate, we did not want to be as exposed to the large, multinational Asian companies, such as Samsung Electronics or Taiwan Semiconductors, which are obviously more leveraged to the global cycle,” Weickart says.
“We really wanted a manager that could provide us with an all cap experience, with small and mid cap companies providing a more focused exposure to the (Asian) domestic demand growth story.
“We definitely wanted a manager that had experience in running dedicated China mandates as we knew that China would become an increasingly important part of the index, while another key aspect was ESG (environment, social and corporate governance).
“Investing in Asia, we wanted a manager that integrated the different nuances of ESG considerations within their investment process.” Cbus found that Comgest was able to address both of these requirements.
Last year, Cbus also added a broader emerging markets strategy and appointed GQG Partners, headed by Rajiv Jain, to the portfolio. “We’re now 100 per cent active in emerging markets and with no pooled fund exposure,” she says.
“We are also looking at continuing to establish a bench of managers across the equity sectors,” Weickart says. “We’ve done a lot of work in building out the emerging markets sector and we have done a number of manager searches, and a more formal bench of reserve managers is important to establish.”
Factors in Asia
Weickart and Cbus’ Quantitative Solutions team more recently embarked on a project that analyses the different style factors that drive emerging markets, including EM Asia and Chinese equity markets. This will help the fund identify the kinds of managers needed to complement the existing portfolio.
“Analyst sentiment, as measured by earnings revisions, and price momentum were the top-performing styles, but you need to be careful with turnover. These are the kind of factors that have strong predictive power and might help shape our thinking regarding what type of managers we need if we proceed down the path of building up our Asian exposure, including a China specialist [manager], she says.
Analyst sentiment, as measured by earnings revisions, and price momentum were the top-performing styles, but you need to be careful with turnover. These are the kind of factors that have strong predictive power and might help shape our thinking regarding what type of managers we need if we proceed down the path of building up our Asian exposure, including a China specialist [manager]
“The other thing that we found, which was quite interesting and probably requires digging a little bit deeper into, is avoiding high volatility stocks. Avoiding the high volatility stocks has been shown to add value, particularly in Asian and Chinese equity markets,” Weickart says.
Cbus’ Quant team also took a look at the value factor in emerging markets over the last 20 years. They found that, while value performed reasonably well during the previous 20 years, this was driven by the performance in the first ten years. Similar to developed markets, this factor struggled during the more recent decade.
ESG in Asia
ESG is a key focus for Cbus, but when it comes to investing in companies in Asia the fund acknowledges that it is more about the journey companies are on.
“If management is strong and has a strong focus on engagement and an adaptive investment culture, then these are the types of companies that are more likely to improve from an ESG perspective,” Weickart says.
“If you’ve got the right company management, then they’re going to want to know what best practice is, because from a long term, sustainability perspective that’s a key aspect. A lot of our managers, and particularly our emerging market managers, are very strong on engagement,” she says.
Financial metrics are important to determine the long term sustainability of a company, but it doesn’t give the full picture which is where non-financial metrics such as ESG considerations are key, Weickart says.
“It is broader than just the financial metrics.,” she says. “One of our managers, GQG, uses investigative journalists as a key part of their investment process to help identify ESG as well as other risks.”
One way to avoid risks stemming from climate change and to avoid climate value traps is through the implementation of a stranded asset overlay, which Cbus has implemented across their systematically orientated emerging market managers, using the MSCI Low Carbon Transition score as a guide. This score underpins the MSCI Climate Change Indexes.
“The Cbus Quantitative Solutions team did a lot of research a couple of years ago, to see what the most appropriate measure was in this space,” Weickart says. “As you know, ESG rating methodologies can be quite different, often generating different ratings for the same company.
“At the time, the team viewed the MSCI Low Carbon Transition score as a good measure, as it also includes elements of more forward-looking considerations. That was one of the key issues with some of the other data providers, which were considered more backward looking,” she says.
With regard to the fund overall, the Cbus Responsible Investment team continues to work on understanding the risks the portfolio faces from climate change perspective.
“One area that we are focusing on at the moment is the impact of decarbonisation as the world moves towards net zero emissions, and the transition risk (and opportunities) this creates not just in equities, but also in other assets that we hold directly.
“For example, from a transition risk perspective, Cbus is beginning work to ensure it can engage with the assets owned to ensure they are moving along the trajectory required to keep global warming to a minimum.
“From a physical risk perspective, we are identifying where assets are likely to be exposed to physical risks as the global temperature continues to rise. We have started our work on assessing physical risk in our property and infrastructure portfolios, so real assets first, and then we’ll be looking at our equities portfolios to see what the key physical risks across the different geographies are.
“For the most part it is about ensuring the companies and regions we invest in are cognisant of the risks they are exposed to and gaining confidence that they are working to reduce those risks.
“But that is still a work in progress and continuing to develop,” she says.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.