As years of simmering tensions between the US and China come to a boil, American pension funds are coming under increased pressure from politicians to divest from mainland Chinese companies.

Many politicians have found the prospect of US pension funds helping to fund China’s growth as a global power to be troublesome. And now is an opportune time for Republicans in particular to double down on these misgivings, with the Trump administration blaming Beijing for the spread of Covid-19 as it seeks to shift responsibility for the escalating death-toll in the US.

For the funds, there is a rising risk attached to investing in a country continually portrayed as hostile to the US.

There are suggestions that President Donald Trump is planning to issue an executive order to force federal government-linked pension funds to pull back from China investments.

If it takes place, it would culminate a year’s worth of such efforts. Last month, legislation for a Taxpayers and Savers Protection Act was tabled in the US to force the Thrift Savings Plan – the pension fund for US federal employees overseen by the Federal Retirement Thrift Investment Board (FRTIB) – to abandon its plan to expand its China exposure by shifting to an MSCI ex-US market benchmark index, 8% of which is in Chinese stocks.

(Update: since this article appeared, Trump has issued the order)

To put this in perspective, HSBC has estimated that shifts in US investor allocations to China caused by index changes could add up to more than $1 trillion by the end of next year.

The FRTIB is sticking to the argument that it is discharging its fiduciary duty in pursuing China investments.

In April, a group of military and intelligence veterans warned the US government that adding Chinese shares to US institutional portfolios would be underwriting China's military industries. That follows efforts last year by US senators including Republican Marco Rubio to block Chinese companies that don’t comply with US auditing standards from accessing its capital markets.

Robert Woll, Hong Kong-based partner and an expert in China private equity at law firm Mayer Brown, believes the mounting anti-China pressure on investors is likely to continue and intensify.

Robert Woll, Mayer Brown

“I believe there is a significant risk that US state pension funds, in particular, will face pressure to divest from PRC state-owned and ‘private’ companies," he told AsianInvestor.

“These investors will almost certainly face heightened scrutiny. I expect this trend to be reflected in legislation, regulatory actions, media coverage, and moral persuasion.”

CONTROVERSIAL INVESTMENTS

Some of the US’s largest pension funds have faced individual pressure for their investments in controversial Chinese firms.

For example, the New York State Teachers' Retirement System and the California State Teachers' Retirement System both have stakes in Hikvision, the Hangzhou-based surveillance equipment manufacturer, which has strong ties to the detention camps in Xinjiang. Rubio has been particularly vocal in calling for them to divest, but other politicians, mostly Repubicans, have backed him up.

Neither pension fund would comment on whether they are considering selling their holdings in Hikvision.

One of Trump’s recent press briefings offered another example of the sort of vulnerability pension funds could find themselves in.

On April 6 Trump asked an Asian reporter at a White House press briefing whether she represented Chinese media. Her answer, that she worked for the Hong Kong-based Phoenix TV, was true – but it elided the fact the company is largely owned and sponsored by the Chinese Communist Party.

In addition, AsianInvestor discovered that the US private equity firm TPG owns a 12% stake in Phoenix TV, meaning their US pension limited partners may indirectly have invested in a Chinese state-dominated television channel.

A TPG spokeswoman declined to comment on AsianInvestor’s questions about whether it had US pension fund clients exposed to the investment.

FIDUCIARY RESPONSIBILITY

The most common defence pension executives use when facing political pressure is that their portfolios are designed to best meet the future needs of plan participants. As such, the managers are discharging their fiduciary duty.

However, current realities are forcing some to offer some nuance to this answer.

Yup Kim, a senior portfolio manager with the $67.21 billion Alaska Permanent Fund Corporation in the US, believes it is fair to question US portfolio managers about the nature of their China investments.

Yup Kim, Alaska Permanent
Fund Corporation 

However, he added that Alaska Permanent’s mandate “is to find the most compelling risk adjusted returns around the world” That includes investing in China.

“Without exposure to the asymmetric growth of certain sectors of the world’s second largest and fastest growing economy of scale, you’ll miss out on a lot of equity value creation,” Kim told AsianInvestor.

Besides, he added, "there are plenty of sectors to invest [in China] that aren’t deemed politically sensitive or of national security concern."

FORCE OF LAW

Market observers predict the runup to the US presidential election in November will intensify the pressure on investors into China.

“Clearly, slowing China’s ascension on the global stage is an issue that largely gets bipartisan support in Congress,” said Kim.

Even a change in president may not ease this pressure.

“These initiatives will probably not be limited to the current Congress or the Trump administration, because the deterioration in US-China relations appears to be occurring on a broadly bipartisan basis,” said Woll.

Could US politicians eventually prohibit US institutions from investing in Chinese companies or funds? Investment experts say it can’t be discounted, but feel it’s unlikely.

“Yes, it’s a possibility, but we don’t set our investment priorities based solely on political noise, as there are many ‘unknown unknown’ risks and numerous outlier scenarios to consider,” said Kim.

Alicia Garcia Herrero, chief economist for Asia Pacific at French bank Natixis, added that she hasn’t seen any evidence that US investors are retreating from the mainland. But their choice of investments could become more selective.

“There is obvious pressure to divest from some companies,” Garcia Herrero told AsianInvestor. “We recently heard from the Harvard endowment they were divesting from a Chinese AI surveillance-related company.”

Chart: Percentage of foreign equity and bond holdings in China