For years investors poured into China, as profitable yields and burgeoning tech companies lured them in with the promise of easy profits in an exploding future global economic superpower. However lately, investors are beginning to say to each other that the reasons to avoid the country are outweighing the reasons to buy in. From unpredictable regulatory campaigns that inexplicably target and hogtie specific companies for months, to economic damage caused by the nation’s obsession with its “zero-Covid” policies that pop up unexpectedly and shut down entire sectors for months, the markets have become rife with risk and uncertainty. And that does not even broach the wobbly real estate sector, which is alternating between refusing to pay bond holders, and seeing customers refuse to pay it for unfinished projects.
It is a stunning reversal for a market once seen as the future of the global economy.
Matt Smith of Ruffer LLP, a $31 billion investment firm that recently shut its Hong Kong office after more than a decade said, “The supertanker of Western capital is starting to turn away from China. It’s just easier to put China aside for now when you see no end in sight from Covid Zero and the return of geopolitical risk.”
Since President Xi took office in 2013, foreign investment in China’s capital markets surged. Xi’s government specifically facilitated channels for capital to inflow, from stock and bond trading links in Hong Kong, to the inclusion of yuan-denominated assets in global benchmarks.
Xi’s goal seemed single minded – to encourage foreign inflows, fund their companies, and energize the Chinese economy to advance the nation on the global economic stage, all while retaining strict control over outflows.
But last year, X’s government showed little regard for foreign investors when it allowed regulators to launch a wave of crackdowns on the nation’s highly profitable tech sector. Shareholders saw crippling losses, as distrust of the government, and the companies subject to its whims, grew. This distrust only grew larger as the nation pursued Covid policies that crippled local businesses, and which ran counter to every other nation’s pandemic policies.
After all of that, now analyses, such as that by EPFR Global in a report this month, show that among emerging market equity funds, allocations to China have dropped to the lowest in three years. Now, instead of debating when to buy into dips in China, companies are debating how to reduce their exposure to China entirely.
One anonymous London-based hedge fund reduced its long positions in China to just one after pressure from US investors. Meanwhile an anonymous Zurich-based investment manager said European pension funds and charities are all asking to be fully withdrawn from China due specifically to geopolitical and governance risks.
Citigroup Inc.’s Asia-based research team said it found a, “surprisingly low level” of client engagement for China on a recent trip to London. They said clients were instead mostly focused on India and Korea.
Xiaolin Chen, who manages Krane Funds Advisors LLC’s business outside the US, said in May at a roadshow, that the manager of China-focused exchange-traded funds encountered harsh pushback from clients who said they didn’t want to invest in the country.
Meanwhile Carlyle Group Inc.’s new $8.5 billion Asia fund will reduce Chinese exposure well below normal, with the void filled by markets such as South Korea, Southeast Asia, Australia and India.
And all of this is despite how difficult it is to divest from China, given its $21 trillion bond market, and stocks valued at $16 trillion onshore and in Hong Kong. It is also despite the fact that it is not smooth sailing in other markets, either, given the crisis in Sri Lanka, commodity prices, energy costs, the threats of recession across the globe, tightening monetary policies, and the strong US dollar.
The bottom line is, making money in China has just become harder. The CSI 300 Index has fallen about 27% from its peak 17 months back, and it lags the S&P 500 by nearly 26 percent. And China’s yield advantage over Treasuries has been wiped out for the first time since 2010, as China’s high-yield dollar bonds have lost 34% year to date.
Jamie Dannhauser, Ruffer’s chief economist, said, “Even if you have a positive macro view on China, it’s very, very hard internally to sell Chinese stocks. It’s become incredibly challenging to build a bullish structural story on Chinese assets.”