Are global investors falling out of love with China?

Foreigner investors have pulled a net $9 billion out of mainland Chinese equity markets this year — with $7.6 billion flowing out in October alone, according to data from the Institute of International Finance. That may be a tiny amount compared to the overall size of the Shanghai and Shenzhen markets. But it’s the first time since new trading links with Hong Kong were opened in late 2014 that more money has left China than entered over the first ten months of the year.

Hong Kong’s own Hang Seng Index, where some of China’s best-known companies are listed, has meanwhile plummeted to depths not seen since 2009. And overseas-based investors have withdrawn money from China’s bond market, the world’s second largest after the U.S., every month since February this year, the IIF figures show.

Analysts say the Federal Reserve’s interest rate hikes this year, which translate into higher returns from U.S. bonds, have contributed to these outflows, attracting money from several other global markets. But they also point to China-specific factors — slowing growth and an ailing property market, the government’s tech sector crackdown and continuing geopolitical tensions with the U.S. — as a perfect storm driving investors away.

“The world’s love affair with Chinese financial assets may blow hot and cold from week to week and month to month, but I think the basic position is that people will be giving China a wider berth in future,” says George Magnus, an independent expert who was formerly chief economist at Swiss banking giant UBS.

The souring mood runs counter to the bullish talk heard from international financiers still keen to expand their businesses in China. Colm Kelleher, the current chairman of UBS, told a conference last week that global bankers remain “very pro-China.”

The poor sentiment also belies the fact that investing in China is easier than ever, thanks to measures taken to open up the country’s markets since 2014. That year, regulators launched a trading link between Hong Kong and Shanghai, known as Stock Connect, which enabled foreign-based investors to buy and sell shares on mainland China’s biggest bourse, skirting the country’s strict capital controls. 

The world’s love affair with Chinese financial assets may blow hot and cold from week to week and month to month, but I think the basic position is that people will be giving China a wider berth in future.

George Magnus, former chief economist at UBS

The scheme — later expanded to include Shenzhen — was spearheaded by Li Keqiang, China’s outgoing premier, who said in 2014 it would promote the “healthy development” of the country’s capital markets. A similar trading link to ease investment in Chinese bonds was introduced in 2017.

A further major development came in 2017 when MSCI, an investment research firm that provides indexes tracked by many institutional investors, announced it would include Shenzhen and Shanghai-listed shares in its popular Emerging Markets index. That move alone ensured billions of dollars would automatically flow into Chinese markets from global funds seeking to replicate the index’s fluctuations. 

“The biggest event [to Chinese capital markets] has really come from institutional investors,” says Adam Wolfe, an emerging market economist at research firm Absolute Strategy. “That’s partly due to the opening of China’s capital account, which made it easier for investors to move in, and then because of that, the inclusion of Chinese assets in the main indices for global bonds and equities… [Index and mutual fund investors are] kind of forced to hold some Chinese assets because of that.”

But the opening of China’s capital markets hasn’t delivered the boon investors may have expected from the world’s second largest economy, whose growth rates, while slowing, have still been ahead of those in most developed countries. 

The total return for investors from Chinese A-shares — those listed in either Shanghai or Shenzhen — has consistently lagged global stocks. Over the last five years, MSCI’s China A-shares index has generated a negative 1.93 percent net annualized return, compared with a positive 5.24 percent return from its All Country World Index, based on figures up to the end of October.

The question on global investors’ minds now is whether sentiment towards China has changed for good, or whether potential policy changes, such as Beijing easing its economically damaging zero-Covid policies, will be enough to restore confidence.

Jonathan Fortun Vargas, an economist at the IIF, a Washington, D.C.-based association of global financial institutions, says the reappraisal of Chinese market prospects this year could prove lasting.

“In the weeks after Russia invaded Ukraine, we noted a possible realignment in emerging-market capital flows away from China, even as flows to other emerging markets remained relatively robust,” he told The Wire in an email. “Rather than a short-term phenomenon, it appears that this shift to outflows is part of a structural realignment, with market participants considering China in a new light.”

In the weeks after Russia invaded Ukraine, we noted a possible realignment in emerging-market capital flows away from China, even as flows to other emerging markets remained relatively robust.

Jonathan Fortun Vargas, an economist at the IIF

Certainly, investors have responded negatively to the confirmation of Xi Jinping’s third term as general secretary at last month’s 20th Party Congress, and the appointment of a loyalist leadership team around him. Xi’s crackdown on the country’s tech sector, alongside his more aggressive national security rhetoric and commitment to strict Covid policies, have all indicated a willingness to stare down financial interests in recent years. Hong Kong stocks dropped more than 6 percent on October 24, the day after the congress closed.

“Everyone was caught wrong-footed by the complete consolidation of power by Xi, and the absence of anyone who would generally be considered out of Xi’s orbit, and hence a potential counterbalance,” says Thomas Gatley, a China corporate analyst at Gavekal, an economic research firm. “The general take is that Xi doesn’t care about markets, and he will keep pushing the ideological agenda and someone has to drag him back to reality. If no one does that, it could be really bad,” Gatley says, noting that the new leadership in Beijing may yet prove more friendly to markets — still a vital source of funding for Chinese companies — than many currently think. 

Alicia Garcia-Herrero, chief economist for Asia Pacific at the French investment bank Natixis, says that prior to the recent political changes in Beijing, the biggest outflows from China came in bonds, particularly those of heavily-indebted real estate companies. The property sector is the “Gordian knot in the economy, and the reason behind poor investor confidence in the bond markets,” she says. “But after the party congress, there were huge outflows on equity, too.”

The apparent sea-change in market views on China sets up a dynamic whereby investor funds may continue to flow out of the country even as big financial companies continue seeking to grow their Chinese presence.

Despite worsening trade tensions between the U.S. and China, major Wall Street banks such as Citigroup, Goldman Sachs and JPMorgan have all been allowed either to launch new businesses in China, or to take greater control of their existing operations in the last couple of years. Major fund managers like Blackrock and Fidelity have been given permission to sell investment products on the mainland.

…I don’t think there is any other market like China. My point is you gotta be there. You just wait. You just hack it out. I don’t think there’s anywhere else.

Carl Walter, an author and former COO of JP Morgan China

Such expansions are mainly aimed at tapping the vast pool of savings owned by domestic Chinese investors. “Most of what they are doing is managing mainland money in mainland assets,” says Victor Shih, an expert on China’s political economy at the University of California, San Diego.

Nevertheless, some analysts think the sheer size of China’s market will put a limit on foreigners’ willingness to abandon it altogether. Put simply, there is no other market of China’s size and potential set to emerge any time soon.

“If you’re in the financial sector [in China] it’s so slow to make progress,” says Carl Walter, a former chief operating officer of JP Morgan China and the author of The Red Dream: The Chinese Communist Party and the Financial Deterioration of China. “But I don’t think there is any other market like China. My point is you gotta be there. You just wait. You just hack it out. I don’t think there’s anywhere else.”

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