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Emerging Markets Are Hot—Except for China
It’s the biggest market in a coveted sector, but foreigners are wary of unpredictable policy moves and a soft economy
By MIA LAMAR And RACHEL ROSENTHAL
Aug. 13, 2016 12:01 a.m. ET
2 COMMENTS
The rush to invest in emerging markets has bypassed the biggest one of all: China.
A year after an equities meltdown and surprise currency devaluation in China, global investors say they remain reluctant to sink money into the country’s markets.
The no-confidence vote has been particularly clear on stocks.
A Goldman Sachs Group Inc. analysis of 1.1 trillion dollars of mutual-fund assets indicates funds currently are “underweight” Chinese stocks by 3.1 percentage points—meaning they allocate that much less cash to Chinese stocks than the country’s weighting in global benchmarks. That is the biggest shortfall against global stock benchmarks in a decade, the investment bank said.
In the smaller universe of emerging-market stock funds, investors have pumped close to 13 billion dollars into such funds overall in the past six weeks, even as they pulled more than 3.5 billion dollars out of China-focused vehicles, according to fund tracker EPFR Global. That makes China one of the few outliers in a rush into emerging-market assets this year that has notched record inflows of cash in recent weeks.
Most foreigners investing in Chinese companies do so through exchanges in New York and Hong Kong, where standards for listing and disclosure to investors are generally higher. Would-be buyers of shares listed in mainland China can invest only through quotas granted by Chinese authorities and, more recently, a trading link with Hong Kong that lets foreign investors freely buy some Shanghai-listed stocks.
The wariness partly reflects how unnerved global investors remain by markets that have proved exceptionally unpredictable, even by emerging-market standards. After surging 60% in the beginning of last year, Chinese stocks tipped into a selloff that sent Shanghai’s benchmark index down as much as 41% from June to August. The index rebounded briefly last fall, then plunged 23% in January. The yuan, meanwhile, logged a 5% loss against the dollar in 2015, following an unexpected devaluation one year ago that helped to spur enormous outflows of money as panicked Chinese sent cash abroad.
Many investors say they are disturbed by steps China has taken to tame market convulsions, from heavy-handed currency intervention and the buying of shares by state-backed funds, to allowing widespread trading suspensions of shares and blaming “malicious” forces for stock-price falls.
Others say they remain concerned about China’s economic slowdown, and suspect conditions may be worse than official figures suggest.
Chinese officials have stressed measures by Beijing to address the concerns of global investors, and played down concerns about growth. “The Chinese economy is a ‘stability anchor’ for the global economy,” Premier Li Keqiang said last month. “Prophecy of China’s economy heading for a hard landing is rarely heard now.”
One of the biggest U.S. investors in China said this month he is worried the country is shifting away from plans for a long-term overhaul of its economy. China maintained a growth pace of 6.7% in the second quarter, a feat economists suspected was driven by ramped-up government spending and credit growth.
“I am increasingly concerned that China is playing a short game, which is in conflict with a sustainable long-term strategy of development and further progress,” said Justin Leverenz of OppenheimerFunds Inc. in an “open letter to China” published on the money manager’s website. Mr. Leverenz manages the 30 billion dollars Oppenheimer Developing Markets fund, the largest actively managed U.S. stock fund focused on emerging markets.
“I think many investors are puzzled as to what’s going on in China,” said Alex Muromcew, a San Francisco-based managing director at TIAA Global Asset Management, which oversees 889 billion dollars.
Mr. Muromcew said his emerging-markets stock fund this year has bulked up on investments in Peru and Brazil, but remains underweight Chinese stocks compared with their weighting in global benchmarks.
“When we talk to Chinese corporates, they are really cautious,” he said.
Investors’ reluctance is a setback to China’s longer-term goal of opening its stock market to the outside world. Chinese shares listed in Hong Kong are down 1.1% in 2016 through Friday’s close, while Chinese stocks listed in the U.S. are barely positive. Mainland-listed Chinese shares have fared much worse, with the Shanghai Composite down 14% in 2016.
By comparison, the broad MSCI Emerging Market Index is up 15% this year.
As of Aug. 12, foreign investors had used only about half of a 300 billion yuan (45.2 billion dollars) quota allotted for purchases of Shanghai-listed stocks through the trading link with Hong Kong that was launched with much fanfare in late 2014, according to data from the Hong Kong stock exchange. As Chinese stocks hummed higher in early 2015, some brokers had predicted the quota would be exhausted by the summer.
“Our issue has been a quality issue with Chinese companies, which we don’t have with Indian companies, where there is a lot more transparency,” said Hugh Young, head of Asia for Aberdeen Asset Management PLC, which manages 403 billion dollars globally. “We’d love to put more money in China because we see ultimately lots of potential. It’s trying to find some nice businesses that are clean…and where we can trust the figures.”
Aberdeen’s 7.5 billion dollars Emerging Markets Fund currently has just a 5.9% weighting in Chinese stocks, versus the 26% weighting of Chinese shares in the fund’s benchmark, the MSCI Emerging Markets Index. The widely tracked index includes only overseas-listed Chinese shares. MSCI chose not to add domestic shares to the benchmark earlier this year.
Foreign buying of Chinese bonds has picked up since February, when authorities made a bid to get more outside investment in the world’s third-largest bond market, after the U.S. and Japan, by opening it to more types of investors.
Foreign holdings of Chinese government and corporate bonds issued domestically rose 15% from February to June, to 764 billion yuan (115 billion dollars), according to the most recent data available from China’s central bank. But much of that buying was done by investors already in the market, such as central banks and sovereign-wealth funds, while new players are still figuring out how to gain access, analysts and investors say.
“You have huge potential for the onshore bond market,” said Jean-Charles Sambor, deputy head of emerging-market fixed income at BNP Paribas Investment Partners in London, who helps manage 1.2 billion dollars in assets. “But flows have been quite limited at this stage….It’s a pretty lengthy process before you can invest.”
Matthew Cobon, fixed-income fund manager at Columbia Threadneedle Investments, which manages 460 billion dollars, holds bonds from Russia, Hungary and Mexico but not China. He is skeptical that China’s current growth level is sustainable, and he is expressing that view by betting that the yuan will fall, a position he has had for a while.
“We’re pretty negative on China,” he said.
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