New bfinance report reveals increasing popularity of China equity strategies amongst institutional investors

From

Weichen Ding

According to bfinance’s recent report, Rethinking China’s Role in Emerging Market Equity Portfolios, investors are reassessing their approach to investing in Chinese equities, supported by fundamental shifts in asset management offerings.

While four in five investors still obtain their China equity exposure solely through Global Emerging Market equity strategies, bfinance clients are increasingly using dedicated China equity strategies, such as A-Shares funds (for onshore equity exposure) or All-Shares strategies (which blend onshore and offshore capability).

A strategic approach towards China

This re-evaluation is partly driven by the growth of China’s equity markets, both in terms of index weightings and overall market capitalisation. It is also encouraged by rising awareness among investors of the different characteristics of onshore China equities, which are still very under-represented in global indices and Global Emerging Market strategies. More recently, The market turmoil of 2020 has showcased diversification, with a clear divergence between Chinese equities and Global Emerging Markets in Q1: while the MSCI EM index lost 23.60%, the MSCI China A index lost just 9.72% and the MSCI China index (largely offshore) lost 10.22%.

Investors are also drawn by an increasingly compelling universe of China-focused equity managers which have, bfinance finds, demonstrated strong alpha generation. There are now more than 60 A-Shares strategies, of which over 40 have track records of longer than three years. Meanwhile, the consultant’s manager research indicates that more than 30 managers are able and willing to offer All-Shares strategies, either with an established or with a new launch that blends strong onshore and offshore capability. In addition, there are over 70 managers offering China Equity strategies – a long-established group primarily focused on offshore equities.

Portfolio possibilities

There are multiple approaches for achieving Chinese equity exposure, each of which brings advantages and disadvantages. These include:

  • investing via a Global Emerging Market equity strategy, which effectively outsources the decision on the China allocation and tends to focus largely on offshore China equities (i.e. underweight A-Shares);
  • investing in A-Shares alongside Global Emerging Market equities;
  • introducing a standalone China All-Shares strategy alongside a ‘GEM-ex-China’ strategy, so that offshore and onshore securities are managed together.

bfinance notes that GEM equity strategies tend to vary greatly in their China exposure and are heavily biased towards offshore equities. All-Shares managers, meanwhile, have the greatest potential for alpha generation with the deepest market (>3500 A-Shares and >1300 offshore listings) and the flexibility to take relative value bets between onshore and offshore equities at market, sector and stock level.

When determining appropriate portfolio construction, investors will want to look closely at the quality of available products and the extent to which strategies complement each other. Bfinance notes the evolving relationship between onshore Chinese equities and Global Emerging Market equities, which have historically demonstrated low correlation (0.53 over 10 years) but now appear – notwithstanding the divergence in Q1 2020 – to be more closely connected.

Outstanding performance

Overall, active managers have demonstrated strong alpha generation, particularly in onshore markets. The average A-shares manager has delivered 5.3% per year over the last five years, versus -6.2% for the MSCI A-Shares index. Meanwhile, the average ‘China Equity’ manager has delivered +5.3% per year versus +3.6% for their typical benchmark – the MSCI China index (90% offshore, 10% onshore).

Weichen Ding, Senior Associate at bfinance, comments: “It is increasingly untenable to remain on the sidelines of the world’s second largest equity market. More investors are beginning to take a strategic approach, as one might traditionally do with markets such as Japan, Europe and the US. Investors examining this space at the moment will encounter a landscape of products and strategies that has changed a great deal during the last five years. Right now, the most noticeable changes are taking place in the All-Shares space: there are still fewer than 20 strategies, but more than 30 managers are able and willing to offer this strategy to prospective clients – for example, by combining existing onshore and China offshore capability together.

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