China is experiencing structural development through rising income, health care improvement and technological advancement – all of which are providing fuel for China’s domestic economic development.
The case for investing in China is reasonably well understood. To recap, China is the second largest market by market capitalisation and represents:
- 18% of world population
- 20% of world GDP
- 27% of global growth
China offshore vs onshore
Most investors will have exposure to the Chinese markets via their global equities and/or emerging market mandates. As of December 2020, the MSCI Emerging Market Index has approximately 40% direct exposure to China. Prima facie this exposure looks substantial, but it is heavily skewed towards the offshore market.
Most of the opportunities are only available in the onshore (A-Shares) market, featuring domestic Chinese companies operating in a growing economy.
To fully benefit from China’s economic and corporate growth, investors will need to increase exposures to this onshore component. However, market accessibility and other constraints remain. The timeline for benchmark (eg MSCI) changes to this strategic exposure remains unclear.
The case for dedicated China allocation?
Beyond the indirect China exposures in the portfolio, should investors adopt a separate China allocation? If so, what is the best implementation approach? Should investors adopt a portfolio completion approach, or should that allocation be carved out of the emerging markets mandate? How should the external manager selection process be managed?
The need to benefit from the inefficiencies of the market certainly justifies an actively managed approach. However, is there scope for a low cost, indexed driven route?
Risks
In recent years, there has been increasing trade and geopolitical tensions between China and US, potentially leading to trends in supply chain disintegration and deglobalisation. The current pandemic has certainly amplified these problems. Australia, unfortunately, has been caught in the crossfires too.
Do these developments negatively impact the economic prospects of investing in China? Or should these be seen as the inevitable emergence of a new world order, where investors risk being left behind?
Should the context of such investment decisions be made on purely economic grounds, or are we allowing our values and political persuasion to shape our perspectives?
Governance & Stewardship
In general, emerging markets present a unique set of challenges for the responsible investor. The evolving governance and regulatory framework pose a significant dilemma for the investor seeking alignment with its ESG credentials.
What does engagement and proxy voting look like, bearing in mind the cultural nuances? In what ways can the investor achieve positive change in Chinese companies?
In partnership with BMO Global Asset Management, we are pleased to host an investor roundtable discussion on the merits and risks of investing in the equities market in China.
