“What is the best way to play Asia ex-Japan in the shadow of the current trade war?”

That’s a key question concerning Jeb Burns, the chief investment officer of Michigan's Muncipal Employees’ Retirement System (Mers).

The $11.6 billion state fund is exploring how it should be allocating to China and the wider region, he explained. Is it better, for instance, to invest around the world's second biggest economy or directly into it?

“We’re taking exposure to China [passively] through the indices,” Burns said, speaking to AsianInvestor last week. “But on the active side we’re asking what the best way will be to make those allocations going forward. We’re spending a lot more time on this than we did a couple of years ago.”

Having started out with traditional index-based exposure to Asia, Mers is likely to build its allocation using active asset managers, rather than using quasi-active strategies based on factors or smart beta.

Jeb Burns

“Growth [in Asia] is going to continue. On the active side, we’re returning to a time when country selection is going to be more important,” Burns said. “I suspect there will be an opportunity for active managers with some country expertise to add value in Asia ex-Japan.”

To this end, it may employ large traditional houses, boutiques, consultants and private market managers and so on, he added.

Mers will also continue to seek out co-investments in China, having done its first such transactions – in private equity – around five years ago, Burns said. It has also looked at private debt opportunities there, he noted, “but we need more time to be comfortable [buying such assets]”. 

“Obviously we’re being a bit more reflective in the current environment [in light of tensions such as around the US-China trade war], but we will continue to look for opportunities.”

One thing Mers will not do is put people on the ground in Asia, as the Teacher Retirement System of Texas is planning. “We’re not big enough to do that,” Burns said.

Indeed, even the $234 billion California Teachers State Retirement System hasn't committed to such a move, despite boosting its own focus on the region.

A more typical way of boosting Asia exposure – and one increasingly being taken by asset owners such as the UK's Coal Pension Trustees – is to hire external managers to run dedicated China A-share portfolios. 

Burns did not provide precise figures for Mers’s exposure to Asian assets. As is common for US state pensions, it does not decide on a certain level of regional allocation, but rather makes its investment decisions by asset class.

ASIA CHALLENGES

While Burns is interested in the region, he recognises the acute risks that investors into Asia currently face.

“Geopolitical risk is the biggest challenge [for investing in the region] right now," he said, citing tensions over trade tariffs and protectionist moves.

Talks will resume in Shanghai this week with the aim of resolving the trade dispute between the US and China, though hopes of any big breakthrough appear to be low. Meanwhile, tensions are simmering in the Persian Gulf over the standoff between Iran, the UK and the US over Iran's seizure of a British oil tanker.

Burns continued: “We know how to deal with and evaluate currency risks, but trade issues are going to continue creating opportunities and risks. You have to pay attention to that, when you go into any region or country.”

This used to be a more prevalent issue on the private side, but now you need to factor it into asset allocation overall [because it’s such a prevalent, long-term issue].”

Asset allocators must be aware that there will be winners and losers, he noted. “Certain industries will probably be unaffected, while certain countries will benefit from trade tensions.”

Burns was referring to issues such as the implications of supply chain disruption leading to foreign manufacturers shifting operations away from China.

If anything, foreign exchange risk is less of an issue now in Asia than at other times because the dollar is strong and Mers tends to accept currency risk in the liquid asset space. It evaluates whether to hedge private market investments case by case.

“Emerging market currencies tend to be at the lower end of the scale [versus the dollar] right now,” Burns said, so there is little FX downside for a dollar-based investor like Mers.

Look out for a full feature in the upcoming (Autumn 2019) edition of AsianInvestor magazine on how US pension funds are investing into Asia.