Updated with correction.
Trump administration officials are discussing ways to limit U.S. investors' portfolio flows into China in a move that would have repercussions for billions of dollars in investments pegged to major indexes and affect investments from pension funds, according to people familiar with the internal deliberations, Bloomberg reported Friday.
"The news today suggesting the U.S. government is considering ways to limit portfolio flows into Chinese companies comes at a sensitive time as the U.S. and China trade discussions continue," said a spokeswoman for Asia-specialist manager Matthews International Capital Management in an email.
"While this is clearly still a developing story and further details will likely emerge, we believe limiting portfolio flows into the country would not be in the best interests of U.S. investors. We encourage the U.S. government to carefully consider the impact this could have on the global economy and potential negative impact on retirement savings for U.S. investors," the spokeswoman continued.
Because China accounts for one-third of global economic growth, larger than the combined shares of the U.S., Europe and Japan, she stressed that "decoupling from that engine of global growth is not going to be in our self-interest."
Matthews Asia managed $27.3 billion as of Aug. 31.
U.S. equity markets, which had been trading higher earlier Friday, ended the day lower with the S&P 500, the Dow Jones Industrial Average, the Nasdaq and the Russell 2000 indexes all closing down.
Much of the impact of any federal effort depends on the actual policy adopted by the Trump administration, sources said.
Among the options the Trump administration reportedly is considering: delisting Chinese companies from U.S. stock exchanges and limiting Americans' exposure to the Chinese market through government pension funds.
Trump administration officials are also said to be examining how the U.S. could put limits on the Chinese companies included in stock indexes managed by U.S. firms, three of the people said, although it's not clear how that would be done, Bloomberg reported.
MSCI Inc.'s February decision to lift the weight of A shares to 3.3% of its emerging markets equity index by November from 0.7% was expected to prompt net inflows from overseas investors of between $65 billion and $85 billion in 2019.
Chinese bonds are also in indexes that underpin billions in U.S. investors' passive investments. Bloomberg was the first to move in April when it started the process to include Chinese renminbi-denominated government and policy bank bonds in its Bloomberg Barclays Global Aggregate index.
Early this month, J.P. Morgan Chase & Co. followed suit, announcing it would begin adding Chinese bonds to its Government Bond Index-Emerging Markets index family in February. Before news of the administration's plans came out, FTSE Russell, in its latest annual country classification review, left China on the index provider's watchlist for potential upgrade and its huge bond market out of the FTSE World Government Bond index for now.
"The devil would be in the details, but clearly such a restriction would be disruptive, expensive and damaging to the markets in the short term," said Charles Wollmann, spokesman for the $26.1 billion New Mexico State Investment Council, Santa Fe.
"The scale of impact is hard to predict, but it's safe to say that it could be exponentially greater than that of the trade war," he said.
The endowment funds' exposure to the region includes 9.3% of its $2.8 billion real estate portfolio in Asia and 12% of its $2.4 billion private equity portfolio in Asia and emerging markets and 11.3% of its $1.6 billion real asset portfolio in developed Asia, which includes China. About 5% of its public equity portfolio is invested in China.
Even investors with small exposure to investments in China are concerned with any policy that would place limits on their investments and investment process, including the $238.3 billion California State Teachers' Retirement System.
As of June 30, China and Hong Kong were among CalSTRS' top 10 geographic market exposures with 1% of the West Sacramento-based pension fund's portfolio across asset classes invested in China and 0.9% in Hong Kong, according to a Sept. 5 report from Christopher Ailman, chief investment officer, to the fund's investment committee.
"Restrictions in investments in specific geographic areas may compromise CalSTRS' investment strategies, reduce diversification of the fund and negatively affect investment performance," said Vanessa Garcia, a CalSTRS' spokeswoman, in an email.
"CalSTRS follows an investment strategy of diversification and passive index management that does not systematically include or exclude any investments in companies, industries or geographic areas," Ms. Garcia said.
One challenging aspect of possible restrictions on U.S. investment in China is the knock-on effect it may have on money managers.
Ardian Infrastructure invests in Europe as well as in North and South America, however, the trade policies still have an impact, said Juan Angoitia-Grijalba, Madrid-based senior managing director, Ardian Infrastructure.
For example, Ardian is invested in solar photovoltaic plants in Chile that have purchase agreements to sell power to a copper mining company, Mr. Angoitia-Grijalba said. China is one of the main consumers of copper. If the U.S.-China trade policy impacts China's economy, development in China will be slow, he said.
"This may have an impact on the copper company, which is my counterparty," Mr. Angoitia-Grijalba said.
If China slows down its use of copper and the mining company starts suffering, it would have an impact on Ardian's investments in the solar plants.
Ardian has $96 billion under management or advisement as of mid-July.
These kinds of restrictions are a logical next step in the escalating conflict between the U.S. and China, but won't have a significant impact on China's economy yet, said Preston Caldwell, an equity analyst at Morningstar Inc., in an email.
He said gross U.S.-to-China capital flows averaged only about $7 billion or about 0.3% of China's gross domestic product) from 2013 to 2017.
Compared to prior actions – the implementation of 15% to 25% tariffs on $500 billion of annual U.S. imports from China – the impact is quite small, Mr. Caldwell said.
In general, China has not relied significantly on foreign capital inflows, thanks to its very large current account surplus historically, but the country's current account will deteriorate further as U.S. tariffs continue to ramp up through the rest of 2019 and early 2020, Mr. Caldwell said.
"Therefore, the restrictions would be important as making it more difficult for China to raise foreign capital to plug any current account deficit which develops in coming quarters. So this is more of a second order or potential impact rather than a large, direct hit to China's economy," he added.
Despite concerns about the implications of investment restrictions, some fund managers have strong doubts that White House talks would materialize into action.
Blaine Rollins, managing director and portfolio manager for 361 Capital, a Denver based boutique manager with nearly $2 billion in assets, said in an email: "This is all fierce trade talk that will go nowhere."
"If the White House were to threaten to issue an executive order to delist Chinese firms from the U.S. exchanges and force U.S. pension funds to divest their Chinese investments, I would expect to see the President's wealthiest and most powerful supporters to push back on him," Mr. Rollins added.
One very large pool of support for the president comes from the private equity community, "which has invested billions of U.S. dollars for their clients into Chinese companies and real estate assets," he continued later.
"Firms like Blackstone and KKR would not want the assets of their many U.S. pension funds frozen or seized as it would directly impact not only their firms' pocketbooks, but also hit tens of millions of retirees dependent upon pension income here in the U.S. So even if the threat was possible to enact, it would be politically devastating to the White House in the event that they want to run for re-election," Mr. Rollins said.
Grady Burkett, an international portfolio manager for $21.5 billion Diamond Hill Capital Management, Columbus, Ohio, said that he'd be "surprised and very disappointed" if said restrictions came to pass.
The firm's recently launched international fund, which has around $11 million in assets, has roughly 8% of its portfolio invested in Chinese businesses.
The new fund is mostly made up of seed capital from the firm itself with some allocations from outside investors, he noted.
"One of the expectations for us as asset management firms is that U.S. exchanges will provide liquidity," he said.
"Anything that could potentially disrupt trading of shares (of Chinese companies) and reduce liquidity, creates an additional risk for our investors," he said.
Several firms, including index providers MSCI and FTSE Russell and money managers Apollo Global Management, the Blackstone Group, Dodge & Cox and Morgan Stanley Asset Management contacted about the administration's plans regarding investment flows to China had no comment. Pension funds the Teacher Retirement System of Texas and Teacher Retirement System of Illinois also had no comment.
Northern Trust Asset Management, Bridgewater Associates, BlackRock, University of Texas Investment Management Co., Dimensional Fund Advisors, Parametric Portfolio Associates, were either unavailable or did not reply.
With wire reports