China funds remain a niche produce for UK discretionary fund managers despite the country’s weighting in MSCI benchmarks with many preferring to outsource allocation to generalist emerging market or regional Asian equity funds.
In 2017, MSCI announced it would partially include China A shares in the Emerging Market and ACWI indices. Of the current 34.2% China weighting in the MSCI Emerging Market index 4% is in A shares. In the MSCI ACWI index, A shares represent just 0.4%.
At a press briefing this month, Matthews Asia China fund manager Andrew Mattock said the country was under owned by global asset allocators and argued emerging market funds do not offer the same exposure to the China story as they used to.
“Am I surprised that we’re not further off where we are? Yes, I am surprised,” said Mattock describing it as the second-biggest stock market globally.
A 2018 survey of institutional investors showed an average weighting of 5.9% to the country, according to Cambridge Associates. It reckoned investors should have between 5% to 10% allocated to the country with a portion of this via dedicated China managers.
DFMs use regional funds for most China exposure
Most UK retail intermediaries Portfolio Adviser spoke with accessed China via regional or global emerging market funds with exposure varying across the risk spectrum.
The Hawksmoor Global Opportunities Fund, for example, has 13% to such funds resulting in around 4% invested in China. Its holding in Aubrey Global Emerging Markets fund, has approximately 55% invested in China, and Prusik Asia holds 34%.
“I would agree that most people do not have enough exposure to China if the main measure for the ‘right’ exposure is the MSCI World Index weighting and its contribution to global GDP,” says Hawksmoor co-head of fund management Daniel Lockyer.
But Hawksmoor takes an unconstrained approach and uses fundamentals to inform its asset allocation, Lockyer says.
EQ Investors currently has 2% directly in China via funds such as Hermes Global Emerging Markets, Hermes Asia ex-Japan, Impax Asian Environmental Markets and Stewart Investors Asia Pacific Leaders.
“This allocation has increased strategically over recent years although on a tactical basis we have currently reigned that exposure in slightly,” says chief investment strategist Kasim Zafar.
The case for a dedicated China allocation
In its 2019 research paper, Cambridge Associates outlined three reasons fund pickers should consider a dedicated China allocation rather than accessing the country via more generalist funds.
First, All China or Greater China mandates are not highly correlated to developed or emerging market equities.
Second, active managers are more likely to outperform. Over a five-year period, 55% did so, compared to 30% in global funds and 52% in emerging market funds. In the US, this figure was just 16%.
Third, Cambridge Associates pointed to a tactical opportunity noting the US-China trade war had hammered valuations with the A share market falling 55% from its peak in 2015 to the time of the paper’s publication in March 2019.
JPM and Fiera top tables for China exposure
Chase de Vere research manager Justine Fearns agrees with Matthews Asia that China is probably under owned relative to its GDP and increased weight in MSCI benchmarks. But governance, political intervention, sentiment driven markets and volatility are reasons to approach China with caution, she says.
The Bristol wealth manager’s exposure to China is via generalist emerging market funds, like JPM Emerging Markets, says Fearns, which incidentally has the second highest allocation to the country in the IA Global Emerging Markets sector with 38.1%.
Only the Fiera Magna Emerging Markets fund has a higher allocation than JP Morgan at 38.3% with 20 funds in the sector having a higher weighting to China than the 34% in the MSCI Emerging Markets index.
Fiera Capital takes and bottom-up approach in its fund and chief investment officer Dominic Bokor-Ingram says it is possible to “find huge pockets of growth” regardless of whether GDP is growing at 4% or 6% thanks to the modernisation of the economy.
China fund picks
Architas likes to pick country funds that have significant resource in China with its fund picks from global fund houses: BGF China, Fidelity China focus, JPM greater China, Schroder Greater China.
Investment manager Quentin De Bottini notes the JP Morgan team has grown from a couple of analysts five years ago to 15 dedicated Greater China product-focused analysts within a broader emerging markets and Asia Pacific equities team of 39 analysts. “Because these are big companies they’ve been able to invest heavily, and as a result, they find opportunities that other people cannot,” De Bottini says.
Within the Architas Multi-Asset Active Dynamic Fund, the highest risk rated fund in the range, China exposure is currently around 9%.
GDIM takes a mixed approach to China versus regional funds for exposure to the country depending on the risk-profile of the portfolio.
Aggressive portfolios have around 15 to 16% in Chinese stocks, whereas this is around five to 6% in balanced portfolios. Baillie Gifford Greater China is favoured as a country-specific fund whereas Janus Henderson Asia Pacific Capital Growth and Baillie Gifford Emerging Market Leading Companies are regional picks.
“A direct China fund may be too high a specific or volatility risk in a balanced portfolio so a more diversified vehicle is often more appropriate,” says GDIM investment manager Tom Sparke.
“In portfolios where a higher risk appetite is used a directly invested fund can give a more targeted exposure to express our view more specifically.”
Emerging markets are becoming less about the China story
China’s shift to a consumption-based economy mean the effectiveness of using generalist emerging market funds to access its growing economy has weakened, Mattock says.
When emerging markets were taking off as an asset class between 2004 and 2007, China was driving commodities growth in other emerging markets like Brazil, Chile, South Africa and Russia, Mattock says.
Although EQ currently uses regional funds to access China it is on the lookout for a dedicated manager with local expertise, says Zafar. Although it has a smaller market capitalisation than the New York Stock Exchange, the Chinese equity market has similar trading volumes and number of companies as the US exchange, he notes.
There are fewer responsible investment funds available for the EQ Positive Impact portfolios, which currently access China via the BMO Responsible Global Emerging Markets and Impax Asian Environmental Markets funds. Zafar expects more to see more options in the space in the near future.