The exceptional economic growth of the Asian region, particularly that of China, compared with most of the rest of the world is prompting some institutional investors to canvass the possibility of considering the region, or even just China, as a separate asset class. They should be wary of taking such a path.
Chris Condon, a former regional head of asset consulting at Russell Investments who now specialises in strategic investment consulting with his own firm, says it if always tempting to want to open new asset classes. “But I always ask the question: what are they bringing to the table?” he says.
“It usually comes down to who is making the asset allocation decisions, how much skill they have and what information they are getting.”
For global industries, such as electronics, what is important is where the revenues are coming from and the nature of the cost structures. For example, Condon says, to consider Samsung as a developing market company is “daft”.
“I’m sure there are a bunch of emerging Chinese companies which should be viewed the same way,” he says.
For local industries, such as property and tourism, the local economies are clearly more important.
An example where some investors “got caught up” in the euphoria of a mega trend was during the technology boom of the mid-to-late 1990s, culminating in “tech wreck” in 2000-2001.
“It was a case where the decision making at the asset allocation level had run to the agents who were least qualified to make the decisions, including asset consultants and investment committees.”
Investors thought everything was different, the investment world had fundamentally changed with P:Es of 40-50. Some stocks didn’t even have an ‘E’.
“If you are going to make a specific allocation to, say, green energy or to China, you have to ask yourself what price you are paying for more difficult questions which might not be being addressed.”
Condon does not dismiss the importance of good local knowledge, however. He says good global equities managers need to have people on the ground, but the stock selection decision should be made by comparing stocks with others in different jurisdictions.
Kim Catechis, a specialist emerging markets investor with Edinburgh-based Martin Currie Investment Management, says there are three paths which can be taken with a China exposure but “perhaps what lies around the corner on each of these paths is not always obvious”. They are:
. The China ‘A’ shares market – designed for inward investment and continually being expanded though still very small. The access point, through the QFII program, means it is difficult to remove money. Plus the level of disclosure for companies is lower, making transparency another negative factor.
. The ‘H’ share market in Hong Kong – much easier to access than the Shanghai market for foreigners but does not have the same range of stocks. It has fewer restrictions on liquidity and higher standards of listing requirements. But it still has exposure primarily to one country and therefore can be volatile.
. A diversified portfolio across emerging markets. This may or may not include access to China ‘A’ shares directly, but particular Chinese themes can be played via the ‘H’ shares and investments can be made in overseas companies which are direct or indirect beneficiaries of Chinese growth.
“For many institutional investors the best way to play China is not through imposing a restriction to one single country. Through diversification and greater transparency an investor can take comfort that they have a better chance of not getting a nasty surprise.”
Catechis, the investment director and head of emerging markets at his firm, is not just talking his own book. Martin Currie has had direct links to China since the 1990s and has a QFII quota for clients who want go down that path.