Investors are turning to emerging markets, especially China, for reliable returns. However markets will have to reckon with increasing intervention from the Chinese government on its blueprint for an equitable society.

The latest research fron Cerulli suggests that the ongoing political turmoil and effects of the pandemic have not dampened investors’ enthusiasm for Chinese funds.

Assets under management in China grew 34 per cent in 2020, with inflows increasing by 21.8 per cent for the year. The Chinese fund market saw a rise in net revenues of 37 per cent, with local equities leading the way. MSCI China reported a near 30 per cent return last year, up 6 per cent from the previous year, according to the global researcher.

Chinese regulatory reform is also helping speed up market development, including fast-tracking equity-related fund applications under reforms introduced in late 2019. It is part of a slew of recent signals that China is opening up its markets and liberalising its banking system to attract inward investment and grow a fledgling wealth management sector serving China's growing wealth classes. However, centrally-delivered political reforms are not making the path easy for international firms setting up shop there or for investors looking to Asia, China in particular, for diversification and stronger yields.

Nevertheless...
“We expect investors to show continued interest in Chinese equities in 2021 and beyond, based on the country’s earlier recovery from the pandemic and its growth prospects relative to other markets,”  André Schnurrenberger, managing director, Europe at Cerulli Associates, said. “As for bonds, investors are set to favour Asian fixed income because it currently offers better yields than bonds in developed markets," he said.

Outside Asia looking in
Global pension fund managers are also looking to Asia for opportunities, Cerulli research shows. The Canada Pension Plan Investment Board and Ontario Municipal Employees’ Retirement System have been growing their Asia-focused teams to expand investments in the region. The Nationwide Pension Fund in the UK and the Iowa Public Employees’ Retirement System in the US have also expressed interest in including more Asian private debt in their portfolios.

“Investors around the world believe that emerging markets, particularly in Asia, are making better progress in their economic recovery from COVID-19. As a result, they are keen to increase their exposure to such markets,” Schnurrenberger said. Investors in emerging markets, including China, Brazil, and South Africa, are also increasing their foreign exposure, he said.

China’s financial markets are not, however without their risks, no less so than in the unpredicatable and explosive recent state intervention.

Regulatory changes in key areas of real estate, the internet, and the education market have caused volatility and woken up investors.

Fiona Cheung, head of global emerging markets for fixed income research at Manulife IM, gave her perspective on the recent markets drama as the state presses on with its longer-term socio-economic goals.

Her investment briefing yesterday went to some lengths to explain the context of these interventions that many saw as heavy handed.

At the heart are shifting economic priorities specifying that "development should result in greater benefits for the everyday lives of citizens as opposed to merely chasing impressive headline GDP figures,” Cheung wrote.

A top priority for China is reversing a shrinking and ageing population by reducing education costs and finding policy levers to promote family growth.

“Education expenses, particularly after-school tutoring, is a significant factor for many families to consider when having children. The legal basis of the recently-released Double Reduction education policy started in 2018 and involved different stakeholders in the drafting process," she said.

The framework was finalised three months ago and released in late July but, she said, it should have minimal market effect as the sector accounts for just 0.7 per cent of China GDP.

In the longer term, changes to education could help alleviate high costs, help raise children into the middle class, free-up more consumption spending, and foster more diversity in the sector, she said.

China's Internet sector
Since the Chinese government put a stop to Ant’s highly anticipated listing last year, regulators have also stepped up surveillance of China's internet giants. Areas under scrutiny relate to banking, anti-trust, data security, and social equality.

The changes, which mainly relate to improving employee benefits, cybersecurity, and curbing monopolistic power, should have limited market impact, she said. "Enhancing protection for employees and customers may lower the overall social risks associated with the sector. A reduction in the monopolistic tactics of internet platforms should also foster market competition and spur economic innovation,” she said.

Oversight of China's real estate sector has also been building over several years. The phrase “houses are for living in not speculating on” is being repeated at high-ranking government meetings, Cheung wrote, with resulting policy changes aimed at curbing profiteering in the sector.

“The average mortgage-related loan-to-value ratio (LTV) in the Chinese banking system is around 50 per cent, and the excess leverage from shadow banking and P2P lending has reduced in the past few years," she said. The People’s Bank of China also performed real estate-related stress testing for the banks in the second half of 2020 to ensure that the system can weather a potential correction, she added.

Broader Asia
Although all markets in the Asia-Pacific region are on track to exceed the global compound annual growth rate (CAGR), China and Korea stand out, with their CAGR expected to reach double digits, according to Cerulli forecasts.

At least 1,300 funds were launched in China in 2020, and RMB3.1 trillion ($475 billion) in assets have come through initial public offerings. A second wave of the pandemic in India in March could see investors sticking with safe and liquid assets, Cerruli said. China and India are set for the biggest growth over the next five years.

A recent trend has been of international banks and wealth managers setting up joint ventures or obtaining various licences to manage funds for onshore Chinese investors. Earlier in August, for example, BNP Paribas won a licence in China to provide custody services for China’s Qualified Foreign Investor (QFI) scheme, which allows it to work directly with foreign institutional investors. In May 2020, Chinese authorities scrapped investment quotas on qualified foreign institutions. Qualified Investors no longer need to apply for any investment quota from the State Administration of Foreign Exchange, aka SAFE. Qualified investors may choose currencies and the timing of inward remittance on their own decisions.

Pictet Asset Management, part of Swiss private banking group Pictet, was awarded a Renminbi Qualified Foreign Institutional Investor quota by China as far back as 2015. Other firms such as JP Morgan, Baring Asset Management, Ashmore Group, BlackRock and BNP Paribas have received quotas.