Investors prepare for push into China market
There are hints of growing interest among U.S. institutional investors in China's $8.4 trillion A-shares market, ahead of its gaining an initial toehold in MSCI's benchmark indexes in May.
While there's still more talk than action, a handful or two of sizable A-shares searches by U.S. defined benefit plans in the past year should prove to be the start of a bigger trend, narrowing the gap between China's 16% share of the global economy and its less than 3% share of global market capitalization, money management executives said.
Prior to a year ago, A shares were seen as a "niche" allocation for investors willing to take "outsized risks," but interest in the market is broadening considerably, said Asha Mehta, a senior vice president and lead portfolio manager, frontier markets, with Boston-based quantitative boutique Acadian Asset Management LLC.
With reforms lowering operational hurdles, bringing forward the day when A shares will account for 10 to 20 percentage points of a global emerging markets portfolio, the number of clients "receptive" to pursuing opportunities in "the second largest market in the world" is growing, said Ms. Mehta.
After three years of study, Acadian will launch a commingled A-shares strategy for institutional clients before the end of January, she said.
The number of searches, while small, has clearly picked up over the past year, said Paul Price, Morgan Stanley (MS) Investment Management's London-based global head of sales.
Early adopters led the push into emerging markets, followed by a wave. For A shares now "we're on the way to a wave," Mr. Price predicted.
Stichting Pensioenfonds ABP, the €403 billion ($484.7 billion), Heerlen, Netherlands-based pension fund for government and education employees, became the latest early adopter in September when it tapped Guangzhou-based E Fund Management Co. to invest €250 million in A shares.
Shanghai and Shenzhen had been tough markets to invest in, but reforms in China have opened up opportunities for institutional investors there now, said Rene van der Zeeuw, the head of emerging markets equities at ABP's Amsterdam-based investment manager, APG Asset Management.
The beta opportunity in China's fast-growing economy is the main attraction but a big market dominated by retail investors should offer opportunities for institutional investors to add alpha as well, said Mr. van der Zeeuw.
Still, A shares is "not a market that should be entered" without adequate preparation, said Mr. van der Zeeuw, adding that after "long consideration," APG opted to tap E Fund's local expertise to avoid any "pitfalls."
A number of managers said U.S. investors have been even more cautious about adding A shares than their counterparts in Europe and Asia but that gap could be narrowing.
Philip Li, senior fund manager and director, investment operations, with Hong Kong-based Value Partners Ltd., said prospective clients he met with on his latest trip to the U.S. in December were more positive about A shares than at any time during his seven years with the firm.
Fears U.S. investors expressed in previous years about the potential dangers of high property prices or excessive credit growth in China appear to have receded, said Mr. Li.
Interest in the A-shares market is coming back "at last," with a number of U.S. institutional investors, including pension funds, becoming more receptive in recent months, agreed Wong Kok Hoi, the founder and chief investment officer of Singapore-based APS Asset Management.
Messrs. Wong, Li and Price all declined to name the investors they've met with recently.
The inefficiency of the A-shares market, where local retail investors account for well over 80% of trading, is another factor that could attract inflows of institutional funds at a moment when valuations globally are stretched, money managers said.
China is a market where active managers can add "significant value" making concentrated, thematic investments in an e-commerce sector "like no country in the world," or health care, education or pharmaceuticals, said MSIM's Mr. Price. "We think there'll be a bountiful harvest out there for alpha hunters," he said.
That contention extends to quant managers, which look to exploit "behavioral errors" by investors to secure alpha, said Acadian's Ms. Mehta.
With 85% of A-shares trading accounted for by retail investors, that market is "rife with behavioral errors," and returns that can be harvested from specific factors such as "growth signals" are as much as "three times what we see in emerging markets more broadly," she said.
It's a market where active management "makes a lot of sense," agreed Rene Buehlmann, Hong Kong-based head, Asia Pacific, of UBS Asset Management. For investors who remain on the sidelines, it will become a question of "how much alpha you could have generated" had you invested, he said.
It's hardly the case that widespread concerns among U.S. investors and analysts about China's debt-fueled economic model and evolving corporate governance standards have evaporated.
David Morton, chief market strategist with Norwalk, Conn.-based investment consultant Rocaton Investment Advisors LLC, said with China's relatively free market economy tied to a relatively "unfree" political system, generating consistent, "monolithic" levels of growth, it's tough for Rocaton executives to be confident enough in China's growth story to urge clients to add separate A-shares accounts.
"I don't see how we would get comfortable enough" with the fact that they haven't blown up yet to conclude they won't do so going forward, he added.
Analysts who believe China's policymakers have the wherewithal to guide the country's fast-growing economy to safe harbors believe such lingering doubts could offerU.S. investors opportunities to begin building long-term positions in China at reasonable valuations.
Kevin Anderson, a senior managing director and Hong Kong-based head of investments, Asia Pacific, with State Street Global Advisors, said his team — which has never been in the "hard landing" camp when it comes to China — believes investors should consider building exposure now to local banks and insurers trading at attractive valuations due to overly pessimistic fears of a credit crisis.
And institutional investors appear more willing to look at the market, said Mr. Anderson, with signs of "some thawing of the perma-bears in China."
If interest in China is growing, the complicated evolution of the country's listed equity markets — with global investors much more familiar with the trillions of dollars of Hong Kong-listed H shares as well as Chinese technology companies listed in New York — ensures A shares won't be the sole beneficiary.
The argument that A shares — listed in Shanghai and Shenzhen — represent the new, entrepreneurial China to which overseas investors want exposure is overstated, noted Aaron Costello, a Beijing-based managing director with investment consulting firm Cambridge Associates LLC.
For example, the record of profitability the Shanghai and Shenzhen bourses required to list there have prompted the information technology giants serving China's 700 million online shoppers to list elsewhere — most prominently Tencent Holdings Ltd. in Hong Kong and Alibaba Group Holding Ltd. in New York.
With Tencent's stock more than doubling in 2017 and Alibaba's up roughly 90%, investors in MSCI's China index, covering H shares and American depository receipts, would have logged a gain of 55% last year, more than double the 20% gain, in dollar terms, by the MSCI China A index, noted Mr. Costello.
Whether A shares, from a valuation perspective, are offering better prospects now than the shares of those information technology heavyweights is something a money manager should determine, said Mr. Costello. That's why Cambridge Associates is urging clients to consider "all China" mandates, which allow the manager to invest in A shares, H shares or ADRs, depending on where that manager spies value at any given time, he said.
Tan Eng Teck, Singapore-based senior portfolio manager at Nikko Asset Management Co., said increasingly clients are asking the firm to make no distinction between Chinese firms listed on the mainland and those listed offshore. Nikko Asset Management last year seeded an "all China" strategy to serve that anticipated demand.
APS Asset Management's Mr. Wong said his firm is seeing the same trend, and will launch a long-only, all-China fund "soon." Three quarters of APS' $3.2 billion in assets under management is currently in A-shares strategies but that proportion is likely to decline, he said. n