Florida State Board of Administration’s investment advisory committee has approved the removal of China and Hong Kong from its global equity benchmark.
The committee approved the measure at its Dec. 9 meeting, a webcast of the meeting showed.
Lamar Taylor, the Tallahassee-based board’s chief investment officer, and Chris Spencer, the board’s executive director, said in the webcast that the U.S.’s deteriorating relationship with China, the associated geopolitical and regulatory risk, and overall underperformance as the primary drivers of the recommendation to remove China and Hong Kong from the global equity benchmark.
As a result, the benchmark for the $205.2 billion Florida Retirement System Pension Plan’s global equity portfolio will change to the MSCI ACWI ex-China ex-Hong Kong index from the MSCI ACWI Investable Market index. In March, the committee will vote on making the formal changes in the board’s investment policy, which would then be up for a vote by board trustees, which includes Florida Gov. Ron DeSantis.
Currently, the target allocation to China is 2.7% within FRS’ global equity portfolio, and the actual allocation within the global equity portfolio is currently 2.4%.
The change in index would change the regional benchmarks within the FRS global equity portfolio to 65.1% U.S. (from 63.3%), international developed markets, 26.6% (from 25.9%); emerging markets ex-China, 8.3% (8.1%); and China, zero (2.7%).
While the benchmark to China within the global equity portfolio will be reduced to zero, it does not mean that the board’s exposure to the country will then be reduced to zero as well.
“We’ve looked at this strictly as risk vs. reward, and the question is: Do we think we're going to get paid to have the exposure in light of the risk involved?” Taylor said in the webcast.
“The likelihood that you'd see a Russia-type event (following its invasion of Ukraine) that brings that exposure to zero, I do think, is unlikely … but don't discount the possibility that the United States government could tell us to have zero exposure in China. This (will have some) impact on us, because we're going to be forced to get out, and it may be when we're forced to get out, everybody else is forced to get out,” Taylor said.
Taylor said the regulatory risk of investing in China is real and cited Florida’s law passed earlier this year that prohibits the board from investing in state-owned entities in China.
“It’s a function of the geopolitics around the fact that it's now unlike it was, really prior to (the COVID-19) pandemic, where there was a fairly benign view about China and its place in the global market,” Taylor said. “So the globe could somehow bring China into its fold, and China would sort of ease up on their human rights issues and so on and so forth, that the power of the economic story would drive these reforms. That didn't pan out. And what's happened is it's been very apparent that China is a competitor economically, it's a competitor politically, it's a competitor militarily.”
He said the recognition of those facts means more action is likely to be taken in response to that reality and that creates risk in terms of impacting the board’s returns.
“Things directionally seem, as far as relations between the United States and China, only to be deteriorating,” Spencer said. “How much of a deterioration, whether that's significant or whether that's a continued, gradual deterioration from an economic policy, trade policy and outright diplomatic policy, that's hard to predict how that's going to look in the future, but it's far more likely that it's going to continue on its current trajectory than it's going to improve and substantively change more to the upside to reduce that risk.”
Spencer echoed Taylor’s point that federal policy or state policy could force the board to eliminate its exposure to China entirely and shut off access to the board entirely.
As of Sept. 30, the FRS pension plan’s actual allocation to global equity was 48.5%; the target is 45%.
