While some Chinese asset owners are able to invest in overseas assets, it’s not all smooth sailing in a rough sea of market ups-and-downs.
China Investment Corporation (CIC) and China Pacific Insurance Group (CPIC) can attest to that.
On the opening panel of AsianInvestor’s sixth Institutional Investment Forum China in Beijing, Yue Li, vice president for multi-asset strategy of CIC, and Benjamin Deng, group chief investment officer of CPIC, told the forum’s audience how various market risks have spelt trouble for their overseas investment strategies.
“Many investors think that we are now in the late cycle and they have started to discuss a potential downturn,” said Li. Added to that are US-China trade tensions, geopolitical conflicts and a low interest rate environment, following a wave of rate-cutting by global central banks, she noted.
And in Deng’s eyes, these risks have translated to one of the biggest hurdles for CPIC to invest in foreign assets.
“From an investor point of view, we can take interest rate risk, credit spread risk, equity risk and liquidity risk, but forex risk is something that I am not willing to bear,” said Deng, “this is mainly because all of the risks in the market, even geo-political risks, manifest themselves in forex risk, making it particularly hard to track, model and predict.”
“In the past few years, countless investors globally have been impacted by forex risk,” he added.
The reason why forex risk is difficult to overcome stems from the fact that CPIC’s liabilities are concentrated in Rmb.
“When we look at constructing a multi-asset portfolio, which could mean allocation to US dollar or EUR or other currency denominated assets, forex risk is one of the biggest challenges,” he said.
Rmb has gradually depreciated against the USD since May last year, breaching Rmb7 to the US dollar in August.
One of the panelists, however, Bai Xueshi, head of asset allocation and macro strategy for Sunshine Asset Management, said that if an investor deployed capital overseas via a diversified basket of investments denominated in different currencies, it would actually strengthen a portfolio, rather than damage investment returns.
Having a portfolio chiefly focused on the domestic market, Deng said that the lifer has struggled to find the right asset manager.
“Domestic institutional investors such as ourselves have little experience in overseas assets, and it’s only by partnering with the right manager then we can start allocating outside of China,” he said.
Both CIC and CPIC have explored ways to stave off these risks and challenges.
“I think we need to strengthen risk management on overseas portfolios, together with a review of asset allocation, as it is really at the core of multi-asset investing,” said Li, adding that investors have various ways to protect overseas portfolios. These include lowering the leverage ratio, stocking up on cash, and ultimately, adjusting one’s overseas asset allocations.
“I think those measures can pretty much fall into two major categories: to protect, or to strengthen,” she said, and likened that to how one would adopt one-off and long-term strategies to protect a house against a typhoon.
“You can put up some defences on the outside, like building a wall – this is to protect. For example, getting a tail risk hedging product can be viewed as protecting from the outside,” Li noted. “They are temporary and tactical: you cannot keep a wall in front of your door forever after the typhoon’s gone.”
Deng, however, noted how hedging tools can aid their overseas portfolio by offering forex protection as the derivatives market develops.
“We have now got three years, or even five years of protection from using derivatives, through a cross currency swap,” Deng said. Previously these instruments only covered two years, at most.
“Not only is the tenor is longer, since the US and China have different interest rates, but when the US dollar is hedged to Rmb, within a three-to-five year timeframe, we can get about 100 basis points of interest rate premium. I would opt for our investments to be hedged against Rmb,” he said.
The solution that will really stand the test of time, would be to diversify through asset allocation, Li said.
She pointed out how a risk-based allocation model helps shelter overseas portfolios from a potential market drawdown, as the fundamental metrics of portfolio construction would have already encompassed various risk factors.
Having said that, Deng said that the question of diversifying risk should depend on the type of investors.
“If we are talking about life insurance, we have an investment horizon of between 10 to 30 years, and the risk within that timeframe and our appetite would be quite different from others, say mutual funds or family officers,” he said, “the correlation and level of volatility we need to consider will also be quite different.”