In a significant development, a substantial withdrawal of funds from Chinese stocks and bonds is eroding China’s influence in global investment portfolios and expediting its isolation from the global financial landscape.
Foreign ownership of Chinese equities and debt has experienced a remarkable decline, amounting to approximately 1.37 trillion yuan ($188 billion), which represents a 17% reduction from its peak in December 2021. This data is derived from Bloomberg calculations based on the latest figures provided by the central bank. Notably, Chinese domestic stocks encountered a record outflow of $12 billion in August alone.
This capital flight aligns with China’s economic challenges stemming from persistent COVID-19 restrictions, a crisis in the property market, and ongoing geopolitical tensions with Western nations. These concerns have led the “avoid China” sentiment to become one of the prevailing convictions among investors, as indicated by Bank of America’s recent survey. Additionally, foreign investment participation in the Hong Kong stock market has plummeted by more than a third since the close of 2020.
Zhikai Chen, Head of Asia and Global EM Equities at BNP Paribas Asset Management, remarked, “Foreign investors are demonstrating a growing reluctance to engage with the Chinese market.” He cited apprehensions related to the property market and a slowdown in consumer spending as key factors behind this trend. “Disappointment in these areas has prompted many foreign investors to reassess their exposure to China,” he added.
While China’s economic woes were once perceived as a potential drag on the global economy, particularly in emerging markets, the reality in 2023 has been quite different. The MSCI China Index, down approximately 7% this year, is poised for its third consecutive year of losses, marking its longest losing streak in over two decades. In contrast, the broader MSCI Emerging Markets Index has gained 3% as investors seek returns in other regions like India and parts of Latin America.
This divergence can be attributed to several factors, including China’s strategic shift toward self-sufficiency across supply chains and its strained relations with the United States. Additionally, the artificial intelligence boom has bolstered markets in the United States and Taiwan while having a lesser impact on mainland Chinese shares. Consequently, China’s weighting in the Emerging Markets index has declined from over 30% at the close of 2021 to approximately 27%.
Simultaneously, the strategy of excluding China from emerging-market portfolios is gaining momentum, with the launch of equity funds that intentionally omit Chinese assets reaching a record high in 2023.
Gaurav Pantankar, Chief Investment Officer at MercedCERA, which manages around $1.1 billion in assets in the United States, highlighted several risks associated with investing in China, including local government financing vehicles, the overhang of housing stock, demographic shifts, regulatory uncertainties, and geopolitical isolation. However, he also emphasized that investment opportunities within emerging markets exist in various sectors.
In the debt market, global investors have withdrawn approximately $26 billion from Chinese government bonds in 2023. In contrast, they have invested a collective $62 billion in bonds from other emerging Asian economies, according to Bloomberg data. This outflow has significantly reduced the inflow of approximately $250 billion to $300 billion that accompanied China’s inclusion in government bond indexes since 2019, as analyzed by JPMorgan Chase & Co.
Selling pressure on the Chinese yuan has driven the currency to a 16-year low against the U.S. dollar. China’s central bank’s accommodative monetary policy stance, in contrast to tightening policies in most major economies, has further weakened the yuan, discouraging foreign investment in local assets.
Regarding corporate debt performance, China appears to have fully decoupled from the rest of Asia, particularly as its real estate sector crisis extends into its fourth year. Approximately 85-90% of China’s corporate debt market is now owned by domestic investors.
All these developments occur in the context of China’s slowing economy, prompting a reevaluation of its attractiveness as an investment destination. Notably, major Wall Street banks, including Citigroup Inc. and JPMorgan, have expressed doubts about Beijing’s ability to achieve its 5% growth target for this year.
Nonetheless, the sheer size of China’s economy and its pivotal role in global manufacturing supply chains mean that it will continue to be a vital component of investment portfolios, albeit to a lesser extent.
China still retains the potential to influence international financial markets through globally traded commodities. As the world’s largest importer of energy, metals, and food, China’s impact extends beyond securities portfolios, establishing ties to the global economy that are likely to remain durable. China’s leading position in clean energy, encompassing solar panels and electric vehicles, exemplifies the expanded potential for trade as nations strive to fulfill their climate commitments.
Karine Hirn, Partner at East Capital Asset Management, emphasized that even as China’s economy faces challenges, certain sectors with structural growth prospects, such as new energy vehicles, consumer-related industries, and parts of the renewables supply chain, continue to offer attractive opportunities for investors.
The CSI 300 Index, representing onshore Chinese stocks, witnessed a 0.7% decline on Friday as foreign investors continued to sell off assets. This ongoing trend has pushed global funds’ exposure to China to its lowest level since October. In contrast, allocations to U.S. equities, which have outperformed global counterparts this year, are on the rise.
For investment managers like Xin-Yao Ng, investing in China requires a nuanced approach, balancing caution regarding structural challenges with the pursuit of opportunities presented by individual stocks. Ng, an Investment Manager of Asian Equities at abrdn Asia Ltd., stressed the need for caution regarding China’s long-term economic outlook and geopolitical risks. However, he also highlighted that China’s expansive and diverse market offers numerous opportunities for astute investors, with broad valuations currently at historically low levels. In his view, it is an intriguing market for fundamental investors focused on stock picking.
By Bloomberg
