It may be getting easier to invest in Chinese stocks, as Beijing opens up the country's capital markets, but that also makes it tougher to decide how to obtain that exposure. Going direct is increasingly an option, but many investors will want to employ asset managers. The question is: which ones?
Mark Brugner, Asia-Pacific head of research for investments at Willis Towers Watson, is heavily in favour of using international fund managers rather than local Chinese firms. The disadvantages of using Chinese managers to get mainland exposure outweighs the advantages, he argued, pointing to issues such as high portfolio and staff turnover and an overly short-termist approach.
Issues with Chinese managers
While onshore managers typically have larger teams, better local insight and “an information advantage” for selecting equities in the A-share market, said Brugner, these benefits tend to be offset by the risks to investors.
In particular, the interests of mainland asset managers tend not to align as closely with those of investors, he noted. Very few Chinese firms are employee-owned, and long-term incentive plans are rare: while offshore managers often defer pay over multiple years, mainland firms typically pay in cash straightaway.
The result is frequent trading characterised by a high degree of herding and a short-term investment outlook, said Brugner. “A disciplined long-term investment philosophy” that managers can articulate clearly, is rare among mainland managers, he noted.
Brugner pointed to the high average portfolio turnover of onshore funds in the A-share market. For offshore firms, this is typically between 30% and 100%; for those mainland players it is typically “north of 400%”. This entails high transaction costs, he noted, and reveals the emphasis of onshore managers place on market timing, which is “a very hard skill for [investors] to identify”.
Chinese firms also struggle to retain talent, he said. Whereas offshore managers often feature stable teams with star managers typically retained for at least five to ten years, it is very rare for good managers in China to stay with their firms for that long.
The asset managers themselves, meanwhile, are frequently subject to corporate activity such as acquisitions, or major reorganisations, he said.
Brugner's comments come at time when Chinese fund houses are already under growing pressure from foreign investment managers moving to expand onshore via wholly foreign-owned entities and other channels.
Asset owners favour local insight
However, some institutional investors value the experience and expertise that local Chinese players can offer.
Jeffrey Tan, Asia investment director at Belgian insurer Ageas, believes being on the ground is crucial. “Things change so quickly [in China], I need to visit every month. There are a lot of inefficiencies concerning information flow which you have to be on the ground to see.” As a result, Ageas prefers partnering with local players, said Tan, who is based in Hong Kong.
The insurer has two joint ventures in China: a 20% stake in a local life insurance firm and a 24.9% stake in an asset manager, which receives business from the life insurer and from third parties.
Tan noted that opportunities in China were highly influenced by regulation. “Everything is so policy driven, so getting a handle about what might happen is useful; everyone [in China] talks about it,” he said. He noted that the government involved the market more in decision-making about regulatory and policy than in other emerging Asian markets.
The head of Asia investments at a large US pension fund manager, who asked not to be named, agreed there were benefits to local insight when it came to predicting regulation, which could have a considerable impact on private equity markets.
“In China, the issue is regulation,” he said. “The IPO market is open for now … [but the government] stops it every now and then.” For instance, China's IPO market was frozen for 15 months between late 2012 and December 2013.
Like many institutional investors, the unnamed US pension fund is shifting assets to private equity markets in search of alpha in the current low-rate environment, said the executive. In China this means mainly buyout deals, he added, where the choice of asset manager is essential.
China is now a two-speed economy, he said, with 'old economy' sectors – such as mining, and other heavy industries – significantly less attractive than tech, media & telecoms (TMT), health, financial services and education. The right managers are shifting strategies as the domestic economy rebalances towards these new industries, he noted.