Chinese assets: The biggest risk for investors would be to ignore them
- Despite Chinese markets’ significant risks and volatility, we forecast China’s onshore public and private markets delivering a substantial return premium over developed markets, as diversification opportunities potentially offset relatively higher volatility.
- Onshore markets continue to open to foreign investors. The mix of investors in these markets is shifting, toward more institutional investors attracted by market reforms, as well as China’s rapidly expanding middle class moving savings into mutual funds and insurance, from cash and real estate. Onshore indices are also tilting toward new economy/growth sectors.
- Foreign investors remain under-allocated to Chinese onshore equities and bonds. The risks are significant, but active management may help investors navigate this environment and, given Chinese asset managers’ wide return dispersion, could be large contributors to total long-term returns.
Recent volatility in Chinese equities has created uncertainty. Yet we still see a strong strategic case for investing in China’s onshore markets – public and private – and forecast a substantial return premium over developed markets for Chinese onshore equity and government bonds. China also has the world’s second largest stock and bond markets, but global investors have insufficient exposure to onshore Chinese assets, on average. China is too big to ignore – yet largely overlooked.
There are certainly potential risks, among them policymakers’ balancing act as they seek to rebalance efficiency and equality in the economy, liquidity and geopolitics. Yet for many long-term investors, the rewards of adding onshore Chinese equities and bonds to global portfolios should outweigh the risks. We anticipate superior risk-adjusted returns as a result of the diversification opportunities potentially offsetting relatively higher volatility. Three structural trends are key for the future of China’s asset markets:
Opening to foreign investors is continuing
Ongoing reform and regulatory change permitting foreign investor participation – including the internationalization of the renminbi – are key. We expect continued reforms to usher in a larger share of international ownership of onshore Chinese assets. The shifts are also impacting private markets (real estate, venture capital, private equity).
The mix of investors is changing
Institutional investors attracted by market reforms should increase in importance in the onshore equity market. In the Chinese government bond (CGB) market, we expect the predominance of hold-to-maturity (often bank) investors diminishing. A key driver should be China’s rapidly expanding middle class moving more savings from cash and real estate into markets, through mutual funds and insurance.
The sector mix is tilting toward new economy/growth sectors
Benchmark indices – and Chinese public and private equity-backed companies overall – are tilting toward new economy/growth sectors where the government wants to channel capital, including consumer goods, technology, and high-end manufacturing.
Sustainable investing is on the rise
Sustainable funds, and green and social impact bond issuance, are growing fast. The government has CO2 emissions reduction goals and a strong resolve to tackle social inequality. While still early days, corporate ESG disclosure is up sharply, to 86% of onshore index companies. New rules on corporate environmental disclosure should help investors decide which companies are ready for new climate policies and other challenges, ahead. As the government seeks to achieve “common prosperity,” some sectors will likely face more stringent regulations (internet, education, health care, real estate), while others stand to benefit (biotech, cybersecurity, insurance).
Progress likely won’t be linear, and not every change will net out to a positive impact for investors. Active management should help investors navigate this environment – and, with the wide dispersion of returns among managers in Chinese markets, alpha may be a large contributor to total long-term returns.
The 26th annual edition explores how the legacy of the pandemic – limited economic scarring but enduring policy choices – will affect the next cycle. Despite low return expectations in public markets, we think investors can find ample risk premia to harvest if they are prepared to look beyond traditional asset classes.