Investing in China
Over the past 20 years, China’s economy has grown fivefold to become the second largest in the world. For years, China’s financial markets lagged the country's economic ascendency, but they are now rapidly making up ground. As a result, over the past five years, global investors have started to diversify into Chinese financial assets, yet many are still significantly underallocated relative to China’s weight in global equity and fixed income benchmarks.
One reason for this behavior is that global investors often lack sufficient understanding of the investment opportunities in China. Our latest report aims to help them overcome their hesitancy by demystifying investing in China. We begin by reviewing the equity and fixed income opportunity sets, including their size, characteristics, and market access. We then detail how best to incorporate these asset classes, including China’s currency, the renminbi, into global portfolios. Finally, we consider the macro, regulatory, and geopolitical risks to investing in China.
In today’s economic environment, understanding the opportunities in China and considering portfolio allocations there is key. Some of the most compelling growth opportunities in the world are originating in Asia, with China at its core, and they appear very promising against a backdrop of low global growth. And as China and the US, along with other Western countries, pursue divergent economic, technological, and political models, exposure to China can improve long-term portfolio diversification.
Yet we can’t highlight the appeal of these investments without also acknowledging that, over the past five years, China’s relationship with the US has become strained, and at times outright hostile, and tensions could linger or worsen over the next decade. This creates a real risk for US and other foreign investors beyond the specific risks discussed in our report. While China has made major strides in internationalizing its markets, there are still meaningful differences between it and other countries. US investors also face the risk of new US regulations constraining their access to China’s markets.
Few investments are without risk, and investors may choose to weigh other factors in their decision whether to even dip their toes in Chinese markets. But it’s important to evaluate the opportunities objectively, with a full picture, and a clear understanding of the operating environment for foreign investors to help you make the best possible investment decision. We hope Investing in China will be a useful resource in this regard.
Why China? Too big and distinct to ignore
Some of the most compelling growth opportunities in the world are originating in China, which is one reason we expect returns on Chinese equities and fixed income assets to be solidly above their developed market counterparts in the coming years. China is striving to innovate and achieve technological self-sufficiency. Its R&D spending is growing twice as fast as the US, and it’s home to the largest stock of supercomputers and industrial robots. China has set the goal of achieving carbon neutrality by 2060, enabled by smarter infrastructure and leadership in battery cell technology for electric vehicles. China is also leading in the digital disruption of the retail and financial industries, accounting for 57% of the global e-commerce market, one of the reasons it is leading in the transition to a cashless society.
The rising tensions between the US and China in recent years have created new risks, but it’s also possible that the two countries pursue distinct economic and technological models that operate in parallel, occasionally in collaboration and at other times in competition. As both countries test their power and influence in the coming years, investors should build portfolios resilient enough to withstand all possible outcomes. This means allocating to Chinese assets with a view considering the country’s economic, political, and financial weight in a fast-changing world.
Equity and bond markets: Booming and rapidly evolving
The universe of Chinese equities is complex, but can be simplified by viewing the markets in stages. Beginning with the universe of all China equities, they can be divided between onshore and offshore. The onshore market, also known as the A-share market, trades in mainland China via exchanges in Shanghai and Shenzhen. The offshore market trades outside the mainland and includes H-shares, or mainland China companies listed on the Hong Kong Exchange, as well as American depositary receipts of Chinese companies. The onshore market has a higher weighting in domestically focused sectors and state-owned enterprises (SOEs), with retail investors playing a large role. By contrast, offshore equities are heavily tilted toward consumer discretionary and communication services, and include the mega-cap internet names, with mostly institutional investors involved. For global investors, the MSCI China Index tracks both offshore (88%) and A-share (12%) stocks.
Chinese bonds also have onshore and offshore markets, but the former dwarfs the latter at roughly USD 16tr versus USD 700bn. Government bonds are the largest segment of the onshore market, consisting of Chinese government bonds (CGBs), finance (or policy bank) bonds, and local government bonds. CGBs are analogous to US Treasury bonds. The offshore market consists mostly of USD bonds issued by SOEs and property developers, but also renminbi-denominated or “dim sum” bonds. Global investor activity in Chinese bonds has increased, aided by the market opening up, index inclusion, and better liquidity, but allocations are still small.
Investor takeaways: Global portfolio considerations and risks
Incorporating Chinese assets into a global portfolio can provide meaningful diversification benefits because China’s domestically oriented economy and monetary policy result in economic and interest rate cycles that often diverge from global markets. Chinese equities and bonds have relatively low correlations to global benchmarks. As a result, adding Chinese assets to global portfolios can increase the expected return and reduce the risk, based on the UBS Global Wealth Management Capital Market Assumptions.
There are many risks to investing in China, including macro, regulatory, and geopolitical risks. Antitrust regulation, for example, has been relatively light-touch on the tech sector, but could become tougher for Chinese internet platforms. Delisting risk for Chinese companies trading on US exchanges has increased, but we believe more Chinese companies pursuing listings closer to home and strong investor interest in China can limit the market impact. Longer-term economic risks include the 100-percentage-point rise in the debt-to-GDP ratio over the past 10 years, and the shrinking working-age population. China’s policymakers however, have ample tools at their disposal to mitigate these risks.