As asset managers - including hedge funds – increasingly search for alpha, many have incorporated emerging market securities into their portfolios, with China being a particularly popular investment destination. A succession of positive market liberalization initiatives – including Stock Connect, Bond Connect, China Interbank Bond Market reform, and the recent abolition of investment quotas on the QFII [Qualified Foreign Institutional Investor] and RQFII [Renminbi Qualified Foreign Institutional Investor] schemes have helped the country’s equity and bond markets attract significant inflows from foreign institutions. However, a recent local regulatory crackdown has taken asset managers by surprise.
China's clampdown hits fund managers.
So, what exactly has happened to spook investors so badly in China? China’s government and regulatory bodies are starting to take a more interventionist role in various sectors across the market, leading to dramatic share price fall for many of the companies being targeted. Take the country’s burgeoning technology industry. Following criticism of China’s regulatory system in late 2020 by Jack Ma, the CEO of Alibaba, the Chinese government suspended the $37 billion IPO of Alibaba’s affiliate group Ant Financial before fining the e-commerce group $2.75 billion for abusing its market dominance. Since October 2020, Alibaba’s US-listed shares have seen $400 billion wiped off their value.
US-listed Shares in Didi, a ride-hailing business, lost $37 billion when the authorities investigated its data security practices and banned the company from signing up new users. Following newly introduced rules, Chinese companies with more than 1m users must pass a security review before being permitted to list overseas. Elsewhere, gaming and social media giant Tencent came under heavy pressure, incurring fines while also having a merger blocked by the country’s market regulator. More recently, the Chinese government has unveiled plans to combat gaming addiction by limiting to three hours the amount of time under eighteens can play games - causing Tencent’s share price to depreciate further.
In addition to targeting internet giants, the Chinese authorities have also honed in on the $100 billion school tutoring industry. Under new regulations, companies that teach school curriculum subjects will be prohibited from making a profit, raising capital, listing on stock exchanges, or accepting foreign investment. Speculation is now mounting that China’s lucrative gambling industry is the next industry to be targeted by the government, sending shares in US casinos operating in Macau – a semi-autonomous gambling hub – tumbling. Since the Chinese government’s aggressive clampdown first began - an estimated $3 trillion has been wiped off the value of the country’s largest companies. As a consequence, asset managers are erring on the side of caution when investing in China.
Shall we stay, or shall we go now?
Foreign fund managers are in one of either two camps on China. Some have been alarmed by the suddenness of the regulatory clampdown and heightened political risk and are now exiting and reallocating their funds into other emerging markets. Conversely, a number of other managers – sensing the attractive prices following the sell-off- are ramping up their exposures. Irrespective, it is clear that political risk is something that international fund managers will need to consider more carefully when investing in the domestic Chinese market.