China's star in ascension

Scroll back to the end of last year and pension fund trustees would have raised their eyebrows and scoffed with incredulity at the suggestion that they should invest their scheme members’ hard-earned funds in China.

Six months ago it looked like the pessimists had won and the hope that China’s economy was decoupled from the West seemed no more than an overly optimistic pipe-dream.

But as the dust settles on the global financial crisis, it is becoming clear that while China certainly felt the tremors, its long-term growth plans have not been derailed.

Ashmore Investment Management head of research Jerome Booth said: “The global financial crisis caused collateral damage to the Chinese economy rather than major harm.”

Booth believed that the global financial crisis has worked in China’s favour and has increased this economy’s ability to stand on its own two feet.

He said: “The rate at which the export market collapsed gave the Chinese government a shock. But it was a useful shock – it encouraged the Chinese government to pump money into infrastructure projects to stimulate the domestic economy.”

At the end of last year the Chinese government announced it would spend four trillion yuan over two years on 10 different areas including low-income housing, water and technological innovation. China still lacks basic utilities from enough clean water to an adequate transport infrastructure.

Booth said: “This stimulus package is already working; China’s economy is recovering strongly from the shock of the global financial crisis.”

Over the medium term Booth said China’s economy will continue its transition from its reliance on exports to one driven by domestic consumer demand. “China’s current economic state could be compared with the US at the start of the mass consumer boom in the 1920s so there is plenty of room for expansion.”

China growth 

Schroders Investment Management’s head of global and international equities Virginie Maisonneuve concurred: “By investing in China, you are investing in one of the world’s largest and fastest growing middle classes. The last time we saw such a huge growth in consumer demand was the birth of the baby boomer generation.”

“The Chinese middle class will rise from 43% of the urban population today to 76% in 2025. This is an increase of 350 million people – more than the current US population – to a total of nearly one billion people.

“At the same time the urban population will rise from 43% of the total population to around 59%. Combining these two figures implies the urban middle class will go from 18.5% of the total population to almost 45%,” she added.

This makes the economic growth prospects for the country of a quality that simply can not be found in the more mature economies of the world.

Towers Perrin Shanghai’s managing principal Haichuan Wu said: “The OECD said recently that it expected China’s economic growth to be 7.2% this year. That’s not bad for a supposedly slow year.”

It is the extraordinary growth of China that makes it such an appealing investment opportunity for pension funds that are struggling to get the kind of returns needed to meet the liabilities of a workforce that is living much longer.

But such returns are not without their risks. RCM’s Asia Pacific chief executive Mark Konyn said: “Like other emerging markets, China’s share prices will experience periods of high volatility. This is further exacerbated by the dominance of retail investors in this market.”

At the end of last year, in the teeth of the global financial crisis, China’s stock market CSI300 fell by 70% to 1,627.76 points on November 4, 2008 but it has since rebounded to 3,237.9 points at the start of July.

Resistance to investment 

Despite there being good reasons to invest in China, many pension funds have yet to be convinced. Watson Wyatt’s head of manager research Asia Mark Brugner said: “As a firm we have not seen much demand from investors around the world to specifically invest in China. They are still confining their interest in the region as part of an investment in emerging markets.

“But when we speak to investment managers they say they have noticed a pick up in demand in China. This needs to be taken with a pinch of salt as they are obviously promoting their funds,” he added.

For those pension fund managers who see the advantage of investing in China, the experience can be akin to staring through a closed glass shop door at a row of jars of sweets – tempting but tantalisingly out of reach.

Many of China’s financial markets are still tightly controlled. China’s currency, the renminbi, is not freely traded on global currency markets and its value is based on a loose peg to the value of a basket of foreign currencies.

That’s not the only impediment to foreign investors. Like any other jurisdiction, investors have to get regulatory approval from the Chinese government. 

But China also makes institutional investors apply for a quota to be able to invest in renminbi quoted shares and bonds. This is known as the qualified foreign institutional investor program, or QFII, pronounced “qoffi”.

Once this quota has been granted, investors then have to spend that quota relatively rapidly; they can not sit back and wait for prices to move in their favour. “Once investors have received their quotas, they have to invest the full quota within six months in the various permissible on-shore investments,” said Watson’s Brugner.

Some investment firms have fallen foul of investors’ current risk aversion. “Given the current lack of investor interest, a couple of institutions have handed back their quotas as they could not find the necessary investors,” said Konyn at RCM

Limited access

The controlled access to China’s financial markets makes it much harder for pension funds to invest in China than other geographical locations. If a fund is large enough, it could justify applying for its own quota but for most pension funds this doesn’t make sense.

There are other options available to pension funds that want to invest in China. They can invest in the pooled funds offered by various investment managers that have applied for quotas.

But this is not quite as simple as buying or selling a few units in UK mutual funds. As the quota has to be rapidly invested, the investment manager will ensure that it has a number of investors lined up before it gets the quota. If a pension fund is not on the list at the very start, it can be difficult to get into these funds.

And it is not just investing money into China that’s difficult; repatriating funds can also be complicated, said Watson’s Brugner.

There is a much simpler alternative – buy shares in those Chinese companies that are listed on the Hong Kong rather than the Shanghai stock exchange.

Invesco Perpetual Asian fund manager Stuart Parks said: “This is a good way of getting access to China’s economy as many of the companies that are floated on the Hong Kong are among the best available in China.”

Those pension funds who find the thought of investing in China too exhausting to contemplate should take heart: the market will become more open to foreign investors over time.

Invesco Perpetual’s Parks said: “In the future the restrictions on overseas investors will lessen. I think that China will be just like Taiwan and South Korea. They started out controlling investor access to the market but eventually relaxed almost all controls.”

RCM’s Konyn concurred: “The Chinese government have said that Shanghai will be an international financial centre by 2020. To achieve that, the Chinese currency must be freely convertible.” Konyn’s believed this is a strong indication that Chinese government will further liberalise the country’s financial markets.

When the time is right

Even if pension funds find it too complex to invest in China right now, that does not mean that it should fall off their radar.

Watson’s Brugner said: “China has grown by an impressive 10% every year for the last 20 years. It is currently the world’s third largest economy after the US and Japan. If it maintains this growth rate, it will become the world’s largest economy in just a couple of decades.”

Brugner has some clear advice for pension fund managers “In the not too distant future China will contribute a significant proportion of the world’s economy. At the moment pension funds have either a tiny or a miniscule allocation to China. They would benefit from gradually increasing their exposure to China over time to reflect the region’s strong growth and the increasing influence of this region on the world economy.”

Ashmore’s Booth is more succinct: “At China’s current growth rate, it will be one of the world’s most important economies by 2020. That’s not something pension funds can afford to ignore.”