China is pariah for global investors as Xi's policies backfire

HONG KONG (BLOOMBERG) - After drawing foreign capital into China's markets for years, President Xi Jinping is now facing the risk of a nasty period of financial de-globalisation. Investors point to one main reason why: Mr Xi's own policies.

Money managers once enticed by China's juicy yields and huge tech companies now say reasons to avoid the country outweigh incentives to buy. They cite everything from unpredictable regulatory campaigns to economic damage caused by strict Covid-19 policies, not to mention growing risks stemming from a wobbly real estate market and even Mr Xi's cosiness with Russian President Vladimir Putin.

It all marks a dramatic about-face for a market that had been developing into a magnet for investors from around the globe, a role that seemed to be China's destiny as the second-largest economy.

"The supertanker of Western capital is starting to turn away from China," said Mr Matt Smith of Ruffer, a US$31 billion (S$43.3 billion) investment firm that recently shut its Hong Kong office after more than a decade because of shrinking demand for on-the-ground equity research.

"It is just easier to put China aside for now when you see no end in sight from Covid-19-zero and the return of geopolitical risk," he added.

Foreign presence in modern China's capital markets has increased markedly since Mr Xi became president in 2013. The government carved out channels to let capital flow in, including stock and bond trading links via Hong Kong, and pushed for the inclusion of renminbi-denominated assets in major global benchmarks. The goal was to encourage inflows, fund private enterprise and energise the economy - all while retaining significant control over capital flowing out.

But Mr Xi's government showed little regard for global investors last year when it unleashed a series of crackdowns on the country's most profitable companies. The result was distrust and confusion over the Communist Party's goals, as well as punishing losses for shareholders. Wariness towards Chinese assets born during the trade war with the United States also increased this year after Russia attacked Ukraine and as Mr Xi insisted on pursuing a Covid-19-zero strategy that has been abandoned by virtually every other country.

The caution is leaving a mark, with allocations to China among emerging-market equity funds falling to the lowest in three years, EPFR Global said in a report this month.

Rather than debate when to buy the dip in Chinese assets, discussions among global investors now focus more on how much to reduce exposure. A Zurich-based investment manager said some European pension funds and charities no longer want China in their portfolios because of rising geopolitical and governance risks.

On a recent trip to London, Citigroup's Asia-based research team found what it called a "surprisingly low level" of client engagement towards China. Clients were largely focused on India and South Korea markets instead, it said.

Krane Funds Advisors - a manager of China-focused exchange-traded funds - faced significant pushback from clients at a roadshow in May, said Dr Chen Xiaolin, who manages KraneShares' business outside the US. Investors said they did not have the confidence to invest in the country, according to Dr Chen.

Carlyle Group's new US$8.5 billion Asia fund will have a lower-than-normal exposure to China, with markets such as South Korea, South-east Asia, Australia and India picking up the slack, people familiar with the matter told Bloomberg this month. British investment firm Artemis Investment Management has less than 4 per cent of its global fund directly invested in China, mainly in state-controlled lender China Construction Bank.

Of course, completely divesting from China is not an easy decision, considering it is home to a US$21 trillion bond market and stocks valued at US$16 trillion onshore and in Hong Kong. Its government bonds still offer diversification, according to Pictet Asset Management chief strategist Luca Paolini.

And it is not as though there are a lot of attractive alternatives. Sri Lanka's debt default and ongoing political crisis have fuelled concern about a wave of distress rippling through emerging markets, and the strong US dollar is adding to the pressure, forcing Chile's central bank to intervene last week.

So, it is perhaps less surprising that M&G Investments recently increased its exposure to Chinese stocks even if it required "the proper awareness, pricing and sizing of risk", said Ms Fabiana Fedeli, the firm's chief investment officer for equities and multi-asset in London.

And despite all the negativity, Rayliant Global Advisors has seen the assets of its Quantamental China Equity ETF more than double to US$111 million since May.

"We are seeing more contrarians looking to use our funds to rebalance into China," said Dr Jason Hsu, chief investment officer at Rayliant. "At this point, cutting out China is not really an investment decision. It is more of an emotional reaction and a career risk/optics decision."