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China infrastructure a tricky investment

Global managers cite opportunities, pitfalls in One Belt, One Road

Aidan Yao, AXA Investment Managers
Aidan Yao said commodities and bonds could also see more investment.

Global money managers are split on how far they and institutional investors can participate in the investment opportunities afforded by China's "One Belt, One Road" program.

Some see the chance to invest in long-term infrastructure deals and infrastructure-linked bonds, as well as the economic growth expected in some of the frontier markets involved. Others, however, are not yet sure how they can get involved and view the move as a power play by China.

The program, initiated in September 2013, aims to strengthen China's rail, road and maritime links with trading partners in Asia, Africa and Europe.

There are a number of potential opportunities for pension funds.

"Generally speaking, institutional investors are all looking for long-dated, high-return projects,'' said Daniel Morris, senior investment strategist at BNP Paribas Asset Management in London. "And (One Belt, One Road) should in theory increase the space where pension funds and insurance companies can conceivably make investments. It opens up the opportunity for more infrastructure investing. Even though everyone likes it, and wants to invest in infrastructure, the reality has been more constrained," Mr. Morris added.

Relieving those constraints was highlighted as a positive by Jan Dehn, head of research at emerging markets manager Ashmore Group PLC in London.

"That frees up room for countries to grow faster before they have inflationary problems," and it also makes the countries more attractive as investment destinations, Mr. Dehn said. "There are more sources for financing, (which), generally speaking, reduces risk for anybody who lends money. And … the additional investment that simply comes along with this whole initiative adds to aggregate demand. That creates more growth, makes for better economies. If they are growing faster, tax revenues are higher, company earnings are higher, default rates tend to fall. Right now, it is particularly important that China has launched this initiative, because one of the really perverse effects of (quantitative easing) is it has acted as a giant magnet for developed markets."

The C$19 billion ($15 billion) Ontario Public Service Employees Union Pension Trust, Toronto, wants to work with an emerging or developing markets country to help it develop a social security system learning from Canadian mistakes, said Hugh O'Reilly, president and CEO. The initiative would cover issues including infrastructure investment.

"We think the OBOR initiative will give rise to a lot of exciting opportunities — investment opportunities potentially, and economic development in the vast area the initiative will cover. So we're looking at the emerging and developing world as a place to be active from an investment perspective, but also from the overall perspective to help in the development of independent, well-governed institutions to help local capital to invest, and also to attract foreign investment," Mr. O'Reilly said. He added the initiative is "something we will want to be thoughtful and deliberate about."

Increased infrastructure can add directly to the GDP growth and job creation of a country, and "really helps these countries be integrated in the global supply chain, and move them up on the development scale," said Aidan Yao, Hong Kong-based senior emerging Asia economist at AXA Investment Managers. He said the initiative is "mimicking" China's growth story of the past 3 decades, improving connectivity, trade and infrastructure.

But there are also wider impacts. "If you think a little deeper … the benefits can be much more contagious. If the infrastructure projects do take off, then clearly there (will be) demand for commodities," with resource-rich countries such as those in Latin America set to benefit from rising demand, Mr. Yao said. "Even companies in developed countries like the U.S. can participate in some of the infrastructure projects."

Craig Botham, London-based emerging markets economist at Schroders PLC, also highlighted the commodity angle. "EM commodity exporters will receive relatively stable (foreign direct investment) flows, countering a possibly slower commodities market and more volatile hot money flows. Carry trades could be more viable as a result."

Mr. Yao said another potential investment opportunity for institutions might be infrastructure-linked bonds, which he said tend to carry higher yields and longer durations. However, he said they do have higher yields for a reason, as they are seen as riskier than government bonds and standard corporate bonds.

However, the backing of One Belt, One Road infrastructure projects might help. "If these bonds are tagging on infrastructure that are engineered by sovereigns or institutions like the World Bank, you have the stamp of approval from the sovereign side, which can significantly boost the credibility of these bonds, and help make them more palatable to long-term real money investors such as pension funds and insurance companies," which need long-term assets to match liabilities, added Mr. Yao.

Beyond infrastructure

Outside the impact of increased infrastructure opportunities, money managers were split on how they can play in the One Belt, One Road field.

"It's hard to argue it's not good to have better ports, roads and transportation," said BNP's Mr. Morris. "The question then is how a Western asset manager takes advantage of this. There I think it's a little bit trickier."

Mr. Botham said because investments are "concentrated so far in areas like Pakistan ports and power generation, and Kazakh agriculture, an OBOR portfolio could be tricky to construct."

Asha Mehta, Boston-based director and emerging markets portfolio manager at Acadian Asset Management LLC, said while being a public equities money manager "limits the opportunities for OBOR (participation), that doesn't mean there are none — and there are some compelling ones."

Ms. Mehta, who spends time on the ground in frontier markets, said China's impact is topical.

"The palpable theme as I cover these markets is the influence and growth China has had over the last several years," she said. "I see the objective (of OBOR) as being around connectivity and trading, improving opportunities for trade and geopolitical relevance; but also soft power, winning hearts and minds."

She highlighted that at a high level, China's funding of infrastructure in these countries "is relatively generous … that infrastructure development is critical to many of the frontier market countries."

Many of the countries where Acadian has a "strong and increased positioning are markets where the relationship with China has become stronger. Access to funding, improved geopolitical standing in the near term … creates investment opportunities. The OBOR infrastructure projects (are at a) relatively early stage, mostly playing out (as) opportunities in Asia." However, she said there are opportunities in other countries such as Nigeria.

Areas of concern

But there are potential pitfalls for investors related to the ambitious project, with politics being a main issue.

"Several countries and regions involved in OBOR routes have traditionally lacked adequate policy or regulatory frameworks, or have material geopolitical risks, which have concerned investors. The governments involved need to ensure that these issues are addressed," said Singapore-based Virginie Maisonneuve, chief investment officer at Eastspring Investments. She said this requires consensus, alignment of interests and "commitment to a shared objective not only among governments but also between the various national and local institutions within governments."

Sources warned there might also be issues around the fact some of the projects will see Chinese companies exporting workers into these countries to complete infrastructure work — although this might also produce investment opportunities.

"Potentially the real opportunities for European institutions lie in investing in those companies that will participate in the build out, rather than investing in the projects themselves," such as Chinese manufacturers, added Mark Ebert, a fund manager at Quaero Capital SA in Geneva, Switzerland. Western companies may also benefit "from increased tourism, consumer demand and logistics requirements that should be a consequence of OBOR." Mr. Ebert runs the Quaero infrastructure strategy.​