Market Views: Axing China stocks from global indices
Counting down to Joe Biden’s administration (January 20), the market is digesting the latest restrictions around Chinese assets that the US put in place last month, amid heightened tensions between the two nations.
President Donald Trump signed an executive order on November 12 to prohibit American investor access to 31 Chinese firms “owned or controlled” by China’s military by January 11. This involves many of the country's largest companies.
Following these sanctions, S&P Dow Jones Indices said on Thursday (December 10) that it would remove 21 Chinese companies from its products by December 21. This came after FTSE Russell was the first to act, saying on December 4 that it would follow suit with eight Chinese companies by December 21. The index provider said more Chinese companies could be removed if the US were to publish an official list of sanctioned securities. MSCI is widely expected to make a similar move.
This is just one of Trump's series of policy measures directed specifically at China. In May, for example, the US imposed stricter disclosure rules and penalties on foreign companies listed in the country, which makes life more difficult for Chinese companies and may force more delistings.
Even pension funds are stepping back. Also in May, a $600 billion US government pension fund halted plans to transfer $50 billion of its investments into a portfolio tracking an index that included Chinese stocks after sustained pressure from the federal administration and Congress.
AsianInvestor asked experts how the latest sanctions would influence investor sentiment and whether Biden would reverse these measures.
The following contributions have been edited for clarity and brevity.
Mathias Neidert, head of public markets (London)
We haven’t been approached by any clients, including those who are invested in China equity, with queries or concerns about this.
The implementation of the ban has been fairly selective so far. FTSE Russell only plans to remove eight Chinese companies out of a list of 31. And we think these eight stocks are only about 2% or 3% of the China A-share index and a more negligible share of global equities.
There will be forced selling by passive investors, so there will be a bit of market impact, but the weight is fairly limited. There will also be selling out of active strategies over time, because US investors must divest from the banned stocks by November 2021. That will spread the market impact, which will make it less visible. So we don’t think we are going to see a significant drop in the price of Chinese shares.
What will be interesting, and probably more important, in terms of international asset owners’ actions will be the market impact of any further decisions by the current administration. Trump is still in office for a good month-and-a-half. He seems keen to do as much as he can against China while he’s there.
In any case, I don’t think that this is the most relevant component of the US-China trade war. Biden will have more important fish to fry in terms of US-China relations.
The consensus seems to be that Biden is unlikely to remove the ban, at least not straightaway. Perhaps removing the measures could be part of negotiations once talks start between China and Biden’s administration.
Jay Kloepfer, head of capital markets research (San Francisco)
Given the fluidity of these events, our clients, by and large, have not notably reacted to the recent executive orders [in the US]. As we gain more clarity, asset owners expect to work with their asset managers to adhere to these restrictions if these orders are not reversed by the next administration.
Our institutional clients employ international equity asset managers to invest in non-US markets on their behalf. These decisions include both country and security selection, and the discretion for both are left to the asset manager, under mutually agreed guidelines, including the appropriate benchmark index and universe for investing.
China is included within the emerging markets indices managed by providers such as FTSE and MSCI, and the managers are hired to manage assets against those indices. Just a handful of our clients have set up China-only allocations, but we expect that many more will consider the idea in the coming years.
Most of our investor clients do not make tactical investment decisions regarding countries based on recent developments but rely on their managers to make those decisions on their behalf.
[As to whether the measures will be retained,] Callan is an investment adviser and we do not make political predictions on the potential for a Biden administration to reverse previous measures.
Javier Capapé, director of sovereign wealth research (Madrid)
Many sovereign wealth funds (SWFs) use indices as the baseline for their global listed passive portfolios. So the exclusion of the Chinese firms in question from the benchmarks will have a strong impact on their shareholdings.
But how exactly Trump’s move will affect SWFs via their listed equity mandates is really difficult to track using public sources. That level of detail is not revealed.
As to whether Joe Biden will retain the sanctions, that will depend on the extent to which he seeks to roll back Trump’s ‘America First’ policy. Some analysts feel it will be easier to undo his predecessor’s foreign policy changes – for example, by re-engaging with Nato, the Iran nuclear deal or the Paris climate accord – than it will be to maintain blue-collar capacity and employment while engaging again on trade agreements with the UK or the European Union.
An interesting, related issue raised by the sanctions is the fact that the companies excluded are in the information, telecommunications, nuclear and chemicals sectors.
Significant private investment has been made into sensible sectors in recent years such as financial technology. That may affect investors trapped with stakes in private market assets such as Ant Financial, following the IPO's recent halt; peer-to-peer lending platform Lufax; [US insurance firm] MassMutual’s Asia business; and [shopping platform] Meituan.
The most active SWF investor in China is [Singapore’s] GIC, especially in real estate, fintech and e-commerce, followed by Temasek, which focuses on venture capital deals with a preference for software, biotech and e-commerce. But China’s military/defence sector has received no significant investments by foreign SWFs.
Paul Sandhu, head of multi-asset quant solutions for Asia Pacific (based in Hong Kong)
BNP Paribas Asset Management
Institutional investors will generally take these new sanctions pragmatically. Some benchmarks may be affected, but the fundamentals for most of the new companies on the sanctioned list have not changed pre-US-sanctions. We may see some price volatility in the short term, but that will quickly normalise.
To mute this dynamic further, the Covid-19 crisis and US stimulus are still front and centre as the main factors driving flows between the US and emerging markets specifically. That will remain the case well into next year.
With regard to how the sanctions should be treated in 2021 by the new US administration, the Joe Biden administration will likely and should take into account the holistic relationship between China and the US and align the new policy objectives to any sanctions, tariffs and regulations currently in place.
In effect, the current administration has put the next administration in a beneficial negotiating position. This means that there will not be any immediate release of sanctions or tariffs on Chinese companies or China itself.
The sanctions themselves may push these companies to be more transparent with respect to international standards, which would be positive overall. It would also create an opportunity for the state department to put everything on the table with respect to the US-China relations and negotiate for the benefit of both nations in a transparent and pragmatic way.
Eliot Hentov, head of policy research (London)
State Street Global Advisors
Most global institutional investors are continually raising their exposure to Chinese assets, both equity and debt. This occurs either organically through continued index inclusion by major benchmark providers or as a strategic choice. Chinese assets benefit from a favourable macro growth backdrop and low correlations with other markets.
It is doubtful that US sanctions can meaningfully affect this longer-term trend. Making access to the Chinese market a bit more costly and cumbersome, however, could reduce exposure overall, but to a limited degree.
With regard to the Biden administration, we do not expect a wholesale reversal of any of these measures but do expect slower regulatory implementation and interpretation.