Regulatory risk and the slow adoption of ESG standards have not deterred global asset owners including insurance companies and pension funds from allocating more resources to China.

Investors are showing a strong interest in China A-shares in particular, with a selective strategy, and alternatives assets which they are using to diversify and to obtain higher returns.  

A large majority of respondents (86%) say they’ve either maintained or grown their China exposure over the past year, with 64% expecting to increase it further over the coming year. Only 14% reported they had reduced their holdings there, according to a newly published report “China position 2021: Sustaining institutional interest” by Invesco on September 30.

Chin Ping Chia, Invesco

“China is already one of the most sophisticated digital economies globally and the country has by no means abandoned its ambition to further advance in this segment. We foresee that the recent increase in regulatory scrutiny will promote healthy competition and support more sustainable competition within the internet sector," Chin Ping Chia, head of business strategy and development, China A investments at Invesco, told AsianInvestor. 

The survey was conducted over June and July 2021 with over 200 asset owners that included pension and sovereign funds, endowments, banks and insurers with more than $500 million assets under management. Geographically, respondents were evenly split with 25% each from Asia-Pacific, Europe, Middle East and North America.

ALLOCATION

China onshore equities is still the most popular asset class for most respondents (52%), followed by onshore fixed income (51%) and offshore equities including Hong Kong-listed shares shares and US-listed China ADRs (50%). These are in line with the 2019 findings.

About one-third of surveyed asset owners, on average, plan to increase what they hold in each asset class: 40% will put more into real estate, 39% will have more direct ownership of companies and 38% will invest more in alternatives.

Asset owners cite two reasons to support positive investor sentiment about China: they believe that many sectors there will be resilient and do not expect US-China tensions to have a lasting impact (see chart below). 

Chia told AsianInvestor that investors are navigating current regulatory risk by allocating to sectors where the technology headwinds are having less of an effect or China A shares are benefiting from growing domestic consumption.

DEDICATED

Over half of survey respondents state they have direct investments in China (defined as the organisation having a dedicated portfolio allotment specifically to gain China exposure), compared with 40% in broader investments, for example through an exchange-traded fund or other thematic global/emerging-market or Asia-focused vehicles.

"We do see a growing trend that investors would allocate into China more with a dedicated mandate instead of gaining China exposure via their global and emerging market exposure, a way they have been using for years" Chia said.

REGULATORY HURDLE

Although the potential is enticing, investing in China is not without its challenges. Tensions between the US and China are likely to persist for the foreseeable future, and according to the report, concerns remain about a lack of trust and transparency in corporate reporting, regulation, fina\ancial intermediaries and financial systems, (see chart below).

Regulators have been gettting more and more strict with companies in a variety of industries. 

In July, ride-hailing company Didi Chuxing went ahead with its $4.4 billion initial public offering (IPO) in New York despite authorities requesting the company to postpone, while they investigated its data security arrangements. And in November last year, regulators cracked down suddenly on another tech giant Ant Group just days before its mega IPO.

An executive at one investor spoke in the report about how his company thinks about regulatory risk not just in China. Mukul Chawla, joint head media, telecoms and technology at Temasek, said the fund has a model where it invests against a risk adjusted cost of capital. “One of many risks is regulation and regulatory change. "But it's not unique to China and I don't believe that it changes our stance on China, which remains unchanged in our optimism,” Chawla noted.

Evergrande's woes, which have rocked China's real estate sector and high-yield bonds market in recent weeks raise more questions about the country for foreign investors: should they continue to expand there? Where should they allocate investments in China and how do they navigate the risks?

ALSO READ: What next as Evergrande misses second coupon payment?

ESG CONCERNS

Regulatory risk is not the only pressing issue for asset owners in China. They also worry about the slow development of ESG principles. In particular, their top three concerns are that too few equities or bond issuers in China meet their standard for the scope or quality of ESG disclosures; ESG-related data from equity or bond issuers in China are not readily available; and ESG-related data from equity or bond issuers in China are too difficult to verify.

"ESG is probably one of the most important trends that we are seeing in the asset management industry. A lot of investors are actually placing ESG considerations when looking at China now.  I think the general view by these investors that China companies ESG’s standard or disclosure practices may not be at the same level as developed markets for now," Chia noted. 

But some big names have decided to shun China assets due to the ESG issues.

Norges Bank Investment Management (NBIM) said on September 28 it would exclude several Chinese medicine firms from its investable list due to “unacceptable risk that the companies contribute to serious environmental damage”. A Norges spokesperson previously told AsianInvestor  that, as of December 2020, 3.8% of its overall assets under management was in China, a tiny portion comparing to its 41.6% exposure to the US.

This article has been edited to state that 14%, not 12%, of global asset owners have reduced their China exposure.