June 5, 2023
Investors have been “de-risking” from China for years
The Group of Seven (G7) drew attention at last month’s Hiroshima summit by calling for a “de-risking” of commercial ties with China. But foreign fund managers have already stolen a march on the policy: They’ve been selling vast amounts of securities over the past two years in response to Chinese leader Xi Jinping’s policies and mounting US-China tensions. International institutional investors have been net sellers of about one trillion yuan ($148 billion) of the country’s bonds since early 2022 and have sparked sharp declines in the shares of Chinese companies, especially those listed in New York and Hong Kong.
This shift in market sentiment has whittled away the flow of capital into China, underlining how de-risking has become a bottom-line imperative as much as a diplomatic strategy. And it does not bode well for China amid growing anxiety about the country’s economic prospects.
China’s economy has failed to rebound as expected from Zero-Covid policies, and it faces profound structural challenges: A rapidly aging workforce and slow productivity growth; widening income inequality; and a crippling property crisis. All this adds up to a difficult straits in which local governments and many companies can’t pay their bills. Even though China doesn’t need foreign capital like it did a generation ago, foreigners’ reluctance to invest will reverberate through the economy over time.
Fund managers—especially those with investment strategies focused on the long-term—are concerned about the political uncertainty created by Beijing’s regulatory crackdown on leading private sector conglomerates and heavy-handed pressure on Western companies. Now the Biden administration is preparing to restrict the flow of US venture capital and private equity to Chinese startups developing sensitive technologies—a step many investors worry is a harbinger of more sanctions to come. Western manufacturers are also taking first steps to leave the country, or at least to implement “China+1” strategies.
Meanwhile, Beijing has been undertaking its own form of de-risking by imposing strict regulations that have choked off the number of Chinese companies launching initial public offerings (IPOs) in the US. China’s bureaucrats are concerned about exposing secrets supposedly contained in the vast troves of data controlled by companies seeking IPOs. Instead, the government is making it easier for these companies to list in Shanghai and Shenzhen. More IPOs have been launched in those markets over the past year than in any other market—but with less long-term, foreign capital to offset the share-price volatility that comes from China’s army of retail investors.
The bottom line for many foreign fund managers is that the risk of investing in Chinese securities has soared over the past year and the returns have not kept up. Those returns are out of reach because of the country’s economic doldrums and anemic corporate profits. As a result, many pension funds and other large institutions have stopped buying China altogether. Instead, they are shifting capital to more promising emerging markets like India, where the economic outlook is brighter and politics less of a worry.
The turn away from Chinese bonds is also a response to the efforts to contain US inflation. As the US Federal Reserve has raised interest rates—and China’s central bank has maintained a loose monetary policy in the face of slow growth—10-year US Treasuries have offered better yields than comparable Chinese bonds. At the same time, the renminbi has weakened against the dollar, potentially making investments in China even less profitable.
Chinese stocks did well during the first year of Covid as China’s exporters rushed to feed the world’s demand for pandemic supplies. But after hitting peaks in early 2021, the shares popular with investors in New York and Hong Kong fell for 20 months. A key reason was Beijing’s regulatory crackdown on tech platforms like Alibaba Group and ride hailer Didi Global, which Chinese regulators forced to delist from the New York Stock Exchange immediately after a successful IPO in June 2021. Foreign investors returned to buying in late 2022 in expectation of an economic rebound as Beijing loosened its harsh Zero-Covid policies. But by Spring they had returned to selling amid disappointment with the Chinese government’s policies, skepticism about Beijing’s belated promises of support for companies that had been targeted in the crackdown, and worries about worsening US-China relations.
This evolution is clear from the performance of the Nasdaq Golden China Index, which tracks Chinese companies listed in the US, and the Hang Seng China Enterprises Index in Hong Kong.
The loss of confidence among US investors outweighed what might have been the salutary effect of last year’s resolution of a dispute between Washington and Beijing over the auditing standards of Chinese companies on Wall Street that had threatened to delist those firms. Trading in some of those shares also has been affected as fund managers shift their investments to some companies’ parallel listings in Hong Kong in anticipation of future delisting—another aspect of the concern about US-China tensions. By the end of March, 53 percent of Alibaba’s “tradeable” shares were registered in Hong Kong, up from 38 percent at the end of 2022.
Some foreign fund managers remain committed to Chinese stocks, especially hedge funds. But they aren’t necessarily the stable, long-term investors the Chinese government seeks.
Beijing is not standing idly by: It continues to provide new avenues for foreign investors, most recently opening a channel for them to hedge bond investments and licensing major Western investment banks to operate wholly-owned fund management businesses catering to domestic Chinese investors. But there is a sense among foreign firms that China will prove less profitable than they once hoped.
Then there are the funds that specialize in early-stage investing: Venture capital (VC) and private equity investors (PE) who provide startups with seed money and help bring them to market. These investors have played a significant role in the development of many leading Chinese technology companies. For example, American VC firms and other foreign investors made 58 investments in China’s semiconductor industry from 2017 to 2020, and China-based affiliates of Silicon Valley VCs provided capital to 67 chip-related ventures in 2020 and 2021.
But since the Biden administration began exploring restrictions on outbound investment, the pace of Chinese investments from abroad by both groups has declined. The share of VC deals in China that include non-Chinese investors dropped to 15.1 percent last year from 2021, the lowest level since 2017. Meanwhile, PE investments in China by American investors declined 76 percent to $7.02 billion last year from $28.92 billion in 2021.
While the China affiliates of some VCs continue to raise funds, the imminent White House executive order is expected to continue cutting into this category of investment. Combined with recent Biden administration restrictions on sales to China of advanced semiconductors and cutting-edge chip-making gear, the message to all classes of investors will be clear: Putting money in China is going to become riskier, and de-risking is only going to become more commonplace.
Jeremy Mark is a senior fellow with the Atlantic Council’s Geoeconomics Center. He previously worked for the IMF and the Asian Wall Street Journal. Follow him on Twitter: @JedMark888.
Image: China stock market price graph display.