Wigmore’s Chief Investment Officers (CIOs) held their Spring 2018 meeting in Shanghai on March 14 & 15.
This edition of the Wigmore CIOs meeting saw the group welcome a variety of guest speakers: a chief economist, a former Ambassador to China, a technology analyst, and the head of a major global consumer company’s Chinese operations. We also met with a number of representatives from Chinese investment firms covering a variety of asset classes. Our meeting concluded with a visit to one of China’s largest and fastestgrowing wealth management firms.
The Chinese consumer appears to have whole-heartedly embraced Deng Xiaoping’s famous (and likely misquoted) slogan “To get rich is glorious”. If Chairman Mao was alive today, he would probably be dismayed to see Shanghai’s streets filled with Porsches and BMWs driving past billboards advertising Rolex and Louis Vuitton.
While there may be legitimate concerns about the transparency of China’s state-owned enterprises (SOEs) and the health of the banking sector, the country’s private sector economy is vibrant and dynamic. The pace of innovation, entrepreneurship, and business growth is difficult for foreigners to appreciate. It was remarked that what gets done in a single year in China would require something like seven years to achieve in other parts of the developed world.
The Chinese investment markets are still in the early stages of their development, and remain highly speculative at present. Investors have a staggering risk appetite, and they have return expectations to match. If it doesn’t promise 20% returns, investors aren’t interested. “Getting rich” still takes priority over “staying rich”.
Private investments are almost exclusively venture and growth stage companies. Once a rarity, the Chinese landscape is now densely populated with “Unicorns” (private start-up companies valued at over $1 billion). Investors boast about how many unicorns they are invested in.
The retail investing public still seems to view the stock market as a casino, leading to repeated bubbles and panics. Investment managers who employ a fundamental approach can generate impressive excess returns (alpha), but their portfolios inevitably come with a big serving of market risk (beta). We met with one such manager who had generated a 26% annualized return since 2004 but still lost nearly 65% in the 2007-08 crisis.
Securities Market Regulators have been inconsistent and heavy-handed with their interventions. When the 2016 stock market bubble began to burst, regulators reacted by banning short selling, and declared that all short positions had to be immediately covered. Some listed stocks were halted entirely, but only for a period not to exceed 36 months. And for some reason, investors collectively shrugged and carried on trading the remaining listings.
While the economy is booming and it may appear that there’s nothing holding back China’s relentless growth, there are a few significant risks.
While the government has tightly regulated the official banking sector, banks and risky borrowers have turned to opaque “off-balance-sheet assets” (also know as the “shadow banking system”). The Financial Stability Board estimates there is $7 trillion in Chinese shadow banking debt, but nobody truly knows how much off-balance sheet debt is outstanding. It could potentially pose systemic risk to the stability of the financial system in China and beyond.
China’s new economy companies, being quite dynamic and mostly equity funded, may be resilient enough to endure a financial crisis, however, the old economy companies (which include banks, SOEs and the majority of China’s largest listed industrial stocks) are still centrally-planned, distinctly bureaucratic, and their true balance sheets can be a mystery. These state-controlled companies could be at risk in a crisis, especially because the interests of their foreign shareholders may not be their highest priority.
Most importantly, it doesn’t appear that China really has any need for foreign capital. There is an over-abundance of domestic wealth, and wealthy Chinese are eager to move their money out of China (which has become difficult since the government initiated a US$50,000 annual limit on capital transfers out of the country). Foreign investors may want to be careful in a market where some domestic investors are looking to get out.
Despite the strong economy and growth prospects, because of the above risks, it is wise to take a cautious approach to direct or public market investments in China. If you decide to venture into investing in China, the goal is to find investment managers who possess the necessary expertise to safely navigate the hidden dangers of the Chinese financial markets, along with the edge to generate reliable returns with reasonable risk levels.