Generali exercising caution on China equities

When foreign institutional investors are asked whether they will boost their allocations to mainland Chinese shares now they are part of the MSCI universe, some, like Italian insurance group Generali, remain guarded. The reason? The extra volatility historically baked into the A-share market.

"Long-term investors like us do not like volatility in investment returns," Yezdi Chinoy (pictured), chief investment officer for Asia at Generali told AsianInvestor as part of a phone interview last month. "That kind of fluctuation is not good for financials or for the predictability of returns."

China is one of the few equity markets in the world with a high level of retail participation, which tends to make it more volatile than most, Chinoy said.

On some estimates, retail investors account for as much as 80% of Chinese equity market trading.

Chinoy admitted that there is more potential to seek actively managed returns in A-shares compared with developed markets, due to the inherent market inefficiencies on the Chinese mainland. But there is always a tradeoff between yield, volatility and risk-returns, he said.

When asked if Generali is poised to put more money to work in mainland Chinese stock markets he said "likely yes" but that the decision would depend more on "potential risk appetite and portfolio constraints” than on MSCI inclusion.

On June 1, index compiler MSCI added 234 China A-shares to its MSCI China and MSCI Emerging Markets (EM) indices. Their combined market capitalisation was subject to a 2.5% foreign inclusion factor (FIF)-adjustment, meaning their aggregate index weightings were 1.26% and 0.39%, respectively.

The second step of the inclusion will coincide with the August 2018 quarterly index review, when the FIF-adjusted market capitalisation of China A-shares will rise to 5%.

Hong Kong-based CSOP Asset Management predicted in May that international funds benchmarking against the Emerging Markets index will shovel $400 billion into A-shares, while JP Morgan believes the A-share weighting increases will attract $230 billion in passive investment flows over the next five years.

OPENING UP

While passive flows from investment intermediaries will help to institutionalise the A-share market, foreign insurers are also increasingly setting their sights on establishing a presence in China after it relaxed the ownership cap. This will mean higher investments in the China onshore market, because they will have to invest in assets denominated in the local currency to match their onshore liabilities as their businesses grow to minimise the foreign exchange risks.

Under the new rules announced in November, foreign life insurers can own up to 51% of a joint venture, rising to 100% after three years.

Since the liabilities and assets of Generali’s life insurance joint-venture in China, Generali China Life, are denominated in the local currency, most of its investments are onshore, Chinoy said. 

But as Chinese markets continue to open up, including insurance, many of the companies already invested in the onshore market will also want to diversify into offshore assets, he said.

Chinese authorities are encouraging greater foreign investor participation to raise standards and introduce better practices, Chinoy said.

Just last month, for example, the authorities removed the limit on withdrawals by Qualified Foreign Institutional Investors. Previously, investors covered by the QFII scheme were not allowed to repatriate more than 20% of the capital they invested in China in order to prevent capital outflows caused by stock market volatility

Hopefully, as foreign investors become more involved in the market they will to some extent help make it more systematic and stable after the A-share inclusion, Chinoy said.

STATE SUPPORT

China’s regulators are well aware of the volatility concerns of foreign investors. So, in an effort to offer some market support and reduce market swings, some large domestic government organisations have emerged as big A-share buyers in the past few years.

They have been dubbed ‘the national team’ by Chinese investors and include institutions like Central Huijin and China Securities Finance Corporation (CSFC), UBS said in a report in May.

Unlike other investors, this national team's goal is to provide stability to the market, and there are some signs that it traded against market trends with the aim of reducing market volatility. Indeed, it is estimated by UBS to have increased its stock holdings by an estimated Rmb1 trillion ($157.8 billion) since the big Chinese stock sell-off in mid-2015.

Chinoy has no problem with that. “I don’t think there is any right or wrong in this … at this stage of the market's development maybe that’s the way,” he said.

The mainland Chinese market operates quite differently to other markets and foreign investors have to understand and adapt to it, Chinoy said.

That said, in developed markets, supply and demand finds an equilibrium freely but in less developed markets, there are often some forms of intervention through state-owned companies. So it's unfair to single out China, he added.

For more insights on investing in China, AsianInvestor is hosting its 5th China Global Investment Forum in Beijing on September 13. For more details, visit the website or contact Terry Rayner via email or on +852 31751963.