A $188 billion exodus shows China’s heft fading in world markets
The withdrawal of substantial funds from Chinese stocks and bonds is having a profound impact, reshaping China’s role in global investment portfolios and signaling a noticeable divergence from the global financial landscape.
Foreign investors have been steadily pulling out their capital from Chinese equities and debt, resulting in a significant decline of approximately 1.37 trillion yuan ($188 billion), equivalent to a 17% decrease from the peak observed in December 2021. This trend has only intensified, with August witnessing a record outflow of $12 billion from onshore Chinese shares alone.
This mass exodus aligns with a series of challenges that China has faced, including a prolonged economic slowdown attributed to COVID-19 restrictions, a crisis in the property market, and ongoing geopolitical tensions with Western nations. These concerns have collectively fostered a pervasive “avoid China” sentiment among investors, causing them to reevaluate their exposure to the Chinese market. This sentiment extends to the Hong Kong stock market, where foreign participation has dwindled by more than a third since the conclusion of 2020.
Zhikai Chen, head of Asia and global EM equities at BNP Paribas Asset Management, has characterized this phenomenon as foreign investors essentially giving up on the Chinese market. The concerns about the property market’s stability and a noticeable deceleration in consumer spending are contributing factors.
Remarkably, although China’s economic challenges had previously raised fears of dragging down the global economy, this has not come to pass in 2023. The MSCI China Index is currently experiencing its third consecutive year of losses, marking the longest losing streak in over two decades. In contrast, the broader MSCI Emerging Markets Index is seeing positive returns, with investors redirecting their capital towards other emerging markets such as India and select regions in Latin America.
In essence, the retreat of funds from Chinese assets signifies growing apprehension among foreign investors, driven by economic uncertainties, property market turbulence, and geopolitical tensions. This shift is reshaping China’s influence in global investment portfolios and possibly heralding an era of increased decoupling from the broader global financial landscape, as investors seek more promising opportunities elsewhere among emerging markets.
The growing divergence between China’s financial markets and the rest of the world is driven by a combination of factors. China’s pursuit of self-sufficiency across various supply chains and its strained relations with the United States have contributed to making other markets less vulnerable to the ups and downs of China’s economy.
This economic decoupling, coupled with the global artificial intelligence boom, has had a more significant impact on markets outside China, such as the United States and Taiwan, while mainland Chinese shares have seen less significant gains. As a result of these dynamics, China’s weighting in the Emerging Markets (EM) index has decreased from over 30% at the end of 2021 to around 27%.
Simultaneously, a growing trend has emerged where investors are increasingly considering strategies that exclude China from their emerging-market portfolios. There has been a record increase in the launch of equity funds that specifically omit Chinese assets in 2023.
Gaurav Pantankar, the Chief Investment Officer at MercedCERA, which oversees approximately $1.1 billion in assets in the United States, points out several risks associated with investing in China. These risks include concerns related to local government financing vehicles (LGFV), an overhang of housing stock, demographic challenges, dependency ratios, regulatory volatility, and geopolitical isolation. Investors are increasingly looking for investment opportunities within the broader emerging markets, recognizing that various pockets of growth and stability exist.
In the debt market, global investors have been pulling funds from Chinese government bonds, amounting to about $26 billion in 2023. In contrast, they have invested a combined $62 billion in bonds from other emerging Asian countries. This shift has eroded roughly half of the $250 billion to $300 billion of inflow that came with China’s inclusion in government bond indexes since 2019, according to JPMorgan Chase & Co.’s analysis.
The depreciation of the yuan against the U.S. dollar has been another factor affecting investor sentiment. Selling pressure on the yuan has driven the currency to a 16-year low relative to the dollar. The People’s Bank of China’s loose monetary policy stance, in contrast to tightening policies in most major economies, has further weakened the yuan and discouraged foreign investors from considering Chinese assets as attractive investment options.
In summary, China’s financial markets are experiencing a growing disconnect from global markets due to various factors, including its push for self-sufficiency, geopolitical tensions, and the unique dynamics of its economy. This trend is leading to a reassessment of China’s role in emerging-market portfolios and is prompting investors to seek opportunities elsewhere in emerging markets with more favorable conditions.
The corporate debt performance in China has notably diverged from the rest of Asia, particularly as the real estate crisis in China’s market extends into its fourth year. A significant shift has occurred, with the majority of the Chinese corporate debt market now being held by domestic investors, accounting for approximately 85-90% of ownership.
This divergence coincides with China’s deteriorating economic conditions, raising questions about its attractiveness as an investment destination. Wall Street banks, including Citigroup Inc. and JPMorgan, express doubts about China’s ability to achieve its 5% growth target for the year.
Despite these challenges, China’s sheer economic size and its central role in the global manufacturing supply chain ensure that it remains an essential part of many investors’ portfolios, albeit with reduced weight.
One avenue through which China continues to exert influence on international financial markets is through globally traded commodities. As the world’s largest importer of energy, metals, and food, China’s impact extends beyond just securities portfolios, establishing lasting ties to the global economy. China’s position as a leader in clean energy, encompassing solar panels and electric vehicles, highlights the expanded potential for trade as the world strives to meet its climate obligations.
Karine Hirn, a partner at East Capital Asset Management, points out that a slowing economy doesn’t affect every sector uniformly. She sees value in areas with strong structural growth prospects, such as new energy vehicles, consumer-related industries, and segments of the renewable energy supply chain.
The CSI 300 Index, representing onshore Chinese shares, experienced a 0.7% decline despite better-than-expected data on retail sales and industrial production for August. As this weakness persists, global funds have reduced their exposure to China, reaching the lowest level since October. In contrast, allocations to U.S. equities are increasing, as they have outperformed global peers in the current year.
For investment managers like Xin-Yao Ng, investing in China involves striking a delicate balance between recognizing structural challenges and seeking opportunities in individual stocks. While there are concerns about China’s long-term economic outlook and geopolitical risks, there is recognition that China’s diverse market offers various investment opportunities. The overall valuation is relatively low, making it an intriguing market for fundamental investors engaged in stock picking.
