Adam Bulkin, Head of Research at Sanlam Investments Multi-Managers (SIMM), said that the resultant volatility on the MSCI China Index, which fell by 13.8% in July, illustrated the significant governance risks that go hand in hand with exposure to Chinese technology firms. Local investors, many of whom are retirement savers, are heavily exposed to this risk because locally-listed Naspers owns a large stake in Chinese tech heavyweight Tencent.
Many governance-related conversations are taking place around fund managers’ boardroom tables across South Africa, with managers being painfully aware that the country’s retirement savers cannot afford another Resilience, Steinhoff or Tongaat. Much of their current concerns are directed towards the risk posed by the weighting of Naspers on the various JSE benchmarks, with fears that investors’ capital would be at risk if further shocks were to emanate from China.
Increasing interference by the centralist Chinese government has already caused severe price movements in the likes of Alibaba and Tencent, with some potentially huge IPOs in the financial sector being cancelled entirely (e.g. Ant Financial). The difficulty facing local and global fund managers is that China remains a big theme. “There are many asset allocators who are recommending a dedicated allocation to China,” said Bulkin. “SIMM does not disagree with the key economic growth drivers that exist in China, but we argue that similar potential exists in other Asia Pacific countries.”
He adds that fund managers who believe China is underrepresented on a particular benchmark, or where the potential growth in the size of the Chinese economy and the innovation going on in that country is not reflected in benchmark weights, should consider the rest of the region. Recent market returns showing that China is not a silver bullet for emerging market returns support his view. For example, US dollar returns on the MSCI China Free Index, year to date, to 31 July 2021, were down by 7.5%, compared to a 16.1% rise in the MSCI India and a 17.2% increase in the MSCI Russia.
SIMM leaves the decisions on geographic exposures to single fund managers. “We leave decisions around allocations to emerging markets (EM) and developed markets (DM), and the country and sector allocations within those markets, to our appointed EM and DM managers,” said Bulkin. These managers are qualified to navigate the nuances that exist in choosing between a Russian commodities producer or a Chinese technology firm and can evaluate each company based on its risk-adjusted opportunities.
The EM managers consider factors such as fundamentals, prevailing market sentiment, valuations and a range of risk and reward characteristics when making country allocations. “We favour EM managers that take a dynamic approach to country exposures over time rather than making long-term static commitments to a single country,” said Bulkin. This flexibility is important to avoid being blindsided by the big thematic drivers. For example, staying loyal to the China theme through 2021 would have meant missing out on the potential in lower multiples in India or the impact of rising oil prices on Russia.
The question becomes how fund managers should approach the growing governance risks that stem from the Chinese government’s more hands-on approach, particularly in the technology sector. Bulkin said it is not surprising that China is pulling the levers at its disposal to rein in the tech giant’s powers. “There are some good arguments to be made that some of the social disruption and polarisation we have seen globally in recent years, and especially in the States, can be directly attributed to social networking companies,” he said. The US government would love to turn the screws on Google, Facebook and others; but are hamstrung by their laws. China does not have similar constraints.
Fund managers must acknowledge the additional risk in their Chinese equity exposures and should be raising red flags around any benchmark that is heavily weighted to that country’s technology sector. For local equity investors, it means assessing their exposure to JSE-heavyweight Naspers. One way to avoid overweight positions in single domestic shares is to diversify into a multi-managed global solution. “Global markets offer a lot more diversification,” concluded Bulkin. “You can be a lot more selective in terms of your allocations and are not limited to individual companies for sector exposure.”
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