Regulatory reform in China in 2020 further opened the country’s markets to overseas institutional investors. The removal of Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII) investment quotas, and the lifting of overseas ownership limits in the mutual fund sector have attracted foreign asset managers to set up wholly foreign-owned enterprises (WFOEs) and apply for onshore mutual fund licenses.
Together with the economic recovery from the pandemic and relatively healthy returns from China A-shares, more institutional investors are looking to increase their exposure to Chinese equities. However, investors still struggle to manage and model the risk of the Chinese equity market, which might be fundamentally different from other major markets.
In a recent webinar sponsored by FactSet, AsianInvestor spoke to experts to discuss the dynamics and nuances of the Chinese equity market, the dominance of China’s state-owned enterprises (SOEs) in the market, other factors investors should take into account when investing in the Chinese equity market, as well as how to standardize market risks and returns.
Joanna Dai, Investment Risk Manager at APG Asset Management Asia
"Apart from the traditional risk factors, macro factors also play a role in the China A share market, including monetary policy and liquidity signals from the People's Bank of China, as well as international macro factors like the monetary stances of the Federal Reserve," she said.
Currently, one usual way for risk managers to quantify and assess the risks of macro variables is to use scenario analysis. Moving forward, it would be helpful if data suppliers could add these factors to risk models systematically.
Regarding the consistency issues with classification data, she believes one solution is to have more transparency in the classification rules employed by different data providers. The other solution is for international investors to have access to more local classifications through international platforms to facilitate their investments in China.
Peng Fei Sun, Group Head of Risk Management at Haitong International Securities Group Limited
"The Chinese equity market has its own traits. The first is that the market is simply too big to ignore for international investors’ global asset allocation. The second is that China's equity market has low correlation with other major economies, which could benefit international investors from portfolio diversification and risk-adjusted returns enhancement."
At the same time, the Chinese government plays a big role in the market, which is unique when compared with other global markets. "The government will tell you what the plans are for the next few years."
Sun also added that environmental, social, and corporate governance (ESG) has become a hot topic in recent years as people are paying more attention to environmental protection. "The stock market of new energy industry did well, including wind energy, solar energy, and new energy batteries, among others," he said.
Cannon Sha, Vice President, Principal Sales Specialist for AsiaPac Analytics at FactSet
“Traditionally there are three ways to categorize beta in a country risk model: style, market, and industry factors.”
While environmental, social, and corporate governance (ESG) has become an important style indicator for Chinese investors to assess long-term stable returns in the past one to two years, another key descriptor of style risk in China is internal and external circulation. “In our research, we found that a key factor was the growing importance of the domestic cycle of production, distribution, and consumption, for it has outperformed foreign revenue-driven companies for the first time in the year 2020.”
It is also important to distinguish SOEs from non-SOEs when assessing market risk because historically they have experienced a different level of volatility under various market conditions.
“In terms of industry risk, a local classification system is needed more than ever to describe the opportunities and risk among industries in a policy-driven market like China. That is why we chose to use the SWS sectors in our model over the other global industry classification systems.”
Jing Luo, Senior Fund Manager at Value Partners
The Chinese stock market on average displays high volatility over the past 20 years; it was among either the top three or the last three by return on investment.
Meanwhile, the market is attracting more institutional investors and foreign investors, as well as companies from different industries.
"One of the major changes that happened in China A-Shares markets is the diversity of corporate structure and industry structure. The market is developing to a mature equity market in terms of both funding and assets. The fast economic growth rate in China provides a fundamental support for the equity market, which makes it an attractive market for long-term investment."
Compared with the global market, SOEs make up a relatively high share in the Chinese equity market. This yields some interesting findings. From 1995 to 2019, SOEs saw 24x growth in revenue, while private companies achieved a 42x increase in revenue in the Chinese equity market. Private firms also surpassed SOEs in terms of the profit rate by 2019. In addition, private firms have been recording a higher expense-to-sales ratio than SOEs over the past 20 years.
"We evaluated the largest 20 non-financial companies by market capitalization and found that they were all SOEs 20 year ago; in 2020, 11 of them were private firms."
Watch the webcast to listen to the full conversation.
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