Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
With China, going direct looks a better bet: bfinance study
While an estimated four out of five big international investors, including Australian super funds, gain their China equities exposures through emerging markets (EM) strategies and funds, a new study by bfinance, the global research and mandates search firm, says that a single-country exposure to China is likely to deliver the best results. More big investors are adopting such an approach.
The study, ‘Rethinking China’s Role in Emerging Market Equity Portfolios’, says that bfinance clients in Australia and New Zealand as well as around the world, are increasingly using dedicated China equity strategies, such as China ‘A-shares’, for onshore China equities, or, sometimes, ‘All-shares’ which blend onshore and Greater China universes, which include Taiwan and Hong Kong. bfinance has a well-staffed Sydney office for Australasia, run by Frithof van Zyp (‘Fridge’).
The study says: “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 this March quarter, while the MSCI EM index lost 23.60 per cent, the MSCI China A index lost just 9.72 per cent and the MSCI China index (largely offshore) lost 10.22 per cent.
“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,” the study says.
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.
The study says 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 (more than 3,500 A-Shares and more than1,300 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 want to look closely at the quality of available products and the extent to which strategies complement each other. bfinance says the relationship between onshore Chinese equities and global EM equities is “evolving”. The relationship has historically demonstrated a low correlation (0.53 over 10 years) but now appear – notwithstanding the divergence in the first quarter of 2020 – to be more closely connected. Overall, active managers have demonstrated strong alpha generation, particularly in onshore markets. The average A-Shares manager has delivered 5.3 per cent a year over the last five years, versus – 6.2 per cent for the MSCI A-Shares index. Meanwhile, the average ‘China equity’ manager has delivered a positive 5.3 per cent a year versus 3.6 per cent for the typical benchmark, the MSCI China index (90 per cent offshore and 10 per cent onshore).
Weichen Ding, a senior associate at bfinance, said: “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…”
– G.B.
