APG Asset Management, one of the world’s largest pension funds, is looking to selectively raise its allocations to China fixed income assets but will likely hold its exposure to a stock market it considers to be extremely volatile.
Gregory Suen, head of China fixed income at the €570 billion ($678 billion) pension fund giant, told AsianInvestor that China’s bond market offers a unique opportunity for aspiring foreign investors, noting that it is “very rare, or never happens, that a new market has such size and depth”.
“Compared with China equity, investing into the fixed income assets in the country for foreign investors is fresher. We don’t have a planned figure so far but we do plan on expanding given the attractiveness of the market,” he said.
Suen declined to reveal APG’s exact exposure to China fixed income, beyond noting that it is currently quite small. The pension fund had between 7% and 10% of its equity investment portfolio in emerging markets as a whole at the end of 2020.
The pension fund has prioritised adding fixed income and property assets in the world’s second-largest economy. Wim Hazeleger, Asia Pacific chief executive at APG, told AsianInvestor in December that the group had expanded Asia real estate team and China fixed income team with 10 new appointments. Three of these report directly to Suen.
The market’s allure remains strong for Suen even after defaults in the country have risen to unusually high levels in recent months. Missed repayments of principal and interest by onshore China companies hit Rmb25.9 billion ($4 billion) at the end of February, almost twice than previous year total amount, according to Bloomberg data.
Suen noted that APG was not too surprised about an increase in defaults, given the stresses of the Covid-19 outbreak and the trade tensions with the US.
Indeed, he argued that the default rate is relative lower than some of the markets, and not necessarily a bad thing. “Defaults are part of a healthy capital market in fact, and we are not too concerned about that.”
In addition, APG considers an increase in defaults appears to be an acceptable risk given the overall yields on offer versus the minimal coupon rates and yields on offer in other large markets.
“Global low yield environment provides China’s fixed income market a better position given the yield advantage,” said Suen. “Also, the correlation of China between other markets is quite low which provides some diversification for the portfolio.”
He added that China is generally on the right track when it comes to gradually opening its capital markets to more foreign investment.
“China has been opening the fixed income market for past few years and everything is moving in the right direction. Though we do expect there will be more relaxation on derivatives market in the country, which could give us more hedging tools and be able to manage the portfolio more efficiently,” Suen said.
International investors can access China's exchange and interbank bond markets via the Qualified Foreign Institutional Investor and RQFII schemes, and invest in its interbank market through Bond Connect. Some central banks, monetary authorities and sovereign wealth funds are also permitted to use the China Interbank Market Direct scheme.
A-SHARE CAUTION ABOUNDS
APG is generally more cautious when it comes to China equities, albeit from having a much larger exposure.
Ajay Cherian, head of global emerging market equities believes China equities (including A-shares, H-shares and American Depositary Receipts) offer a one-of-a-kind attractiveness given the large size and diversity of its market for new investors. Yet despite this, APG is content to stick with an emerging market exposure that stood at 7% to 10% of its portfolio at the end of last year.
APG declined to break out its specific China exposure, but it uses the MSCI Emerging Market Index as its emerging markets benchmark. This suggests its China exposure to be 3% to 4% of its equity portfolio, given that China's weighing in the MSCI index was almost 40% of February.
The pension fund's willingness to maintain its China weighting is down in large part to its willingness to see how its current strategic investments in the country pan out.
“Before any expansion, we would like to consider how China is growing compared with other emerging markets, such as its economy scale and business development,” said Cherian.
“In the following years we would like to see whether China would outpace other emerging market peers in economy growth; whether the country has some new companies or industry which could see higher growth; how many unicorns the country has compared with other parts of the world,” he added.
APG’s current China A-share investment strategy is very concentrated. It has invested into around 30 companies and overweighs companies in China’s consumption sectors, Cherian said. He added that APG is keen to work with local partners to give its portfolio time to go through an entire business cycle instead of shifting its exposures frequently.
This focused approach makes sense, given that China’s A-share market is heavily retail investor dominated and very volatile. At the end of February China had 148 million individual A-share investment accounts, according to China Securities Depository and Clearing Corporation data. Less than 1% were associated with institutional investors, with retail investors accounting for 80% to 85% of daily trading volumes.
“Within emerging markets, the level of institutional investors involvement is lower than that in some of the developed markets, which could result in risk and volatility,” said Cherian.
To handle its China stock exposure APG has a total four experts, two in-house and two from mandated manager Beijing-based E Fund Management (E Fund). They are part of a 17-strong global emerging markets team working at APG. While the pension fund has no plans to add to the its emerging market exposure, were MSCI to lift the weight of China in the index APG would follow suit.
One way APG is seeking to minimise its onshore risk is by working with local partners. The pension gains China-tailored research, including environmental, social and governance work, from E Fund Management. It is the largest mutual fund manager in China with a total Rmb2 trillion ($310 billion) assets under management as of December 2020.
“Getting the ESG data can be difficult because global data providers may not have sufficient access to the relevant local information,” he noted, highlighting the importance of supplementing APG’s internal team knowledge with external expertise.
The partnership between APG and E Fund can be traced back to September 2017 when the Dutch asset manager committed €250 million to a E Fund’s China A-shares fund with a responsible investment focus. APG in November 2019 launched another fixed income strategy in China, together with E Fund.