Why China and India remain in favour
Given the stock and bond selection opportunities and the macro growth outlook, China and India are two markets hard to ignore
REFORM and market opening will drive a steady flow of funds from Europe into the capital markets of China and India in 2018. These are not the easiest emerging markets to access but given the stock and bond selection opportunities and the macro growth outlook, China and India are two markets hard to ignore.
Already, the inclusion of China’s A shares in the MSCI emerging markets index in June this year is spurring offshore funds to set up onshore to participate in China’s stockmarkets. Among those granted licenses to sell onshore funds include Aberdeen Standard Investment, Blackrock, Fidelity International, Schroders and UBS Asset Management, among others.
More recently, Bloomberg Barclays Global Aggregate Indices also announced its plan to include renminbi-denominated government securities and policy bank bonds in the index starting April 2019. When fully accounted for, these Chinese bonds will be the fourth largest currency component following the US dollar, euro and the Japanese yen.
India’s strong economic fundamentals, favourable demographics, intention to further increase and simplify the quota and system for foreign portfolio investors (FPI) as well as the attractive yield pick-up are among the reasons behind the increased activity among offshore investors in a country predicted to be the world’s third largest economy by 2030.
“China and India are perceived by investors as large but also complex markets,” explains Anand Rengarajan, head of securities services, Asia-Pacific at Deutsche Bank. “Being large, they are attractive from an investor's standpoint, so investors are still enduring some of the difficulties in getting access notwithstanding recent efforts by India and China to make it easier.”
Leverage in China
An indebted China with 270% of debt to GDP according to one estimate has to also represent risk. Inevitably, this could lead to bad debt problems for the banks. But speakers at The Asset London Investor Dialogue seem less perturbed.
“I would not let that put me off as a stock picker,” says Ross Teverson, head of strategy, emerging markets, Jupiter Asset Management, which has US$71.5 billion in assets under management. “There are some fantastic stock-picking opportunities in China. In our emerging market funds, we currently have about 16% exposure to China. That is a lot less than the 30% that China represents of the MSCI emerging market index. Nonetheless, it tells you that we are finding a number of opportunities we really liked.”
Arnab Das, head of emerging markets macro research fixed income at Invesco, which has US$934.2 billion of assets under management, observes that everybody tends to be focussed on the large amount of debt in China and rightly so. “What people tend to emphasize less is the high rate of savings,” he points out.
“China currently saves about 50% of GDP or about US$6.5 trillion to US$7 trillion of annual flow,” he explains. “That’s more than all the other large economies put together.” If a financial crisis happens, Das believes that there are deep pockets in China, which are much deeper than many other places to help fix that problem.
The flipside of that benign view is, Das continues, “that if you save that much and most of those savings are trapped through capital controls, home bias and some direct measures by the state to keep savings in various places and to direct savings to companies and sectors, you are pretty likely to get some bad debt”.
It was a problem that did threaten to spill over to the rest of the world in 2015 and 2016, especially after the August 2015 devaluation of the renminbi. “The Chinese authorities were able to contain that problem by clamping down on capital outflows,” he explains. “Because they clamped down on all sides of the balance sheet, that is one of the main reasons why we are not having this potential financial crisis, which we have been talking about for many years. It was [also] because the state either controls or owns a lot of the banks and corporates or has imposed greater authority over them.”
India challenge and return
In the case of India, Rengarajan shares that the FPI regulation was launched a few years ago and basically opened up India’s market for much simpler access. “If you look at the experience people have endured after FPI was enabled – the fourth year since the FPI has come into existence – people still find some aspects of it fairly challenging.”
He relates that the regulators are looking at forming a small team of people to look into what can be done to further refine it. “We are part of that. There is the opportunity to get much better,” he maintains. “In the current form, while we can say it is way better than what it was a few years ago, it is still fairly complicated. Documentation requirements are still onerous in certain parts.”
While hurdles remain, Indian regulators have introduced changes that have been positive. “As a bond investor, the reform I cared most about was the shift towards inflation targetting, which started even before the [Modi] government got on board,” says Kieran Curtis, senior investment manager for emerging markets at Aberdeen Standard Investments, one of the largest active managers in the UK with US$820 billion of assets under management. “And the reason why is that for the first time you can actually make real return on an Indian government bond, which for most of my career has not been possible.”
This article is an abridged version of The view from London: Why China and India remain in favour, which will be published in the April print edition of The Asset magazine. Please contact us for details on how to subscribe.
16 Apr 2018