For super funds and their advisers

Mercer’s case for separate China mandates

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The discussion about the best way to build and manage an appropriate exposure to China is becoming more urgent. Mercer has helped investors with some new research.

In a paper entitled: ‘Positioning Your Portfolio for the Future of Emerging Markets – the case for a dedicated China equity allocation’ the global advisory and funds management firm argues that a separate allocation is about more than the exposure to a growth market. It’s about the extra value which can be added in portfolio construction.

The paper says: “Although higher economic growth is often touted as the primary reason for allocating to China’s onshore markets, this should just be seen as an additional potential benefit.

“The real attraction of China’s onshore market stems from the enhancements a standalone allocation can make to an overall equity portfolio due to its low correlation with other equity markets and the abundance of alpha opportunities.”

Mercer advocates an allocation of between 5-10 per cent of a portfolio to both China’s onshore and offshore equities markets through either the China ‘A Shares’ (Shanghai)mandates or ‘All China’ mandates.

“The alpha potential within the China onshore market is significant, but there are also specific ESG and geopolitical risks. Consequently, Mercer recommends the use of active management to mitigate these risks when accessing Chinese equities.”

The offshore markets are mainly those listed in Hong Kong, such as ‘red chips’, ‘P chips’ and ‘H shares’, although ‘H shares’ are also listed on the main Shanghai board and are incorporated in mainland China. ‘N shares’ are listed in New York and incorporated in Hong Kong.

Mercer, generally, recommends that investors should have an allocation to emerging markets of at least market index weight – but preferably of up to 25 per cent of equities – with an overweight driven largely by exposure to China. As of last December, all emerging markets made up just 12 per cent of the MSCI All Country World Index (ACWI).

Although other big advisory firms and some fund managers have pressed investors to make separate country allocations in the past, for most Australian super funds, the up-take on the notion has been small to date. NSW State Super is the most recent to have made a separate allocation and only a handful of other big funds have done so over the years.

However, this may change if the suggestion, recently endorsed by global manager Capital Group, that investors look at Asia ex-China mandates as a new cohort, in much the same way as they have perceived Asia ex-Japan since the 1990s.

The rationale for doing so is the same: Japan got so important it swamped the Asian index. China makes up 40 per cent of the MSCI ACWI (as of December 2020), compared with 5 per cent in 2000. This proportion will increase as MSCI further relaxes the inclusion hurdles for China A shares. The index already understates the true value of the investable universe in China.

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