Ramping up equity exposure

Larry Wan is chief investment officer at Zhongrong Life, a Beijing-based insurance firm with Rmb18 billion ($2.94 billion) in assets under management.

He previously worked with Citic-Prudential Life Insurance, KBC Goldstate, HSBC Jintrust and Orient Securities. Before returning to China in early 2003, Wan worked as an analyst at The Yankee Group, a Boston-based consulting firm.

Q Please outline your asset allocation.
A It has changed a lot in the past two years. Most of our money is invested in fixed income – bonds, bond funds, money-market funds, certificates of deposit [CDs] and cash. Until 2013 we had less than 10% in equities, as we had a dim view of that market. But starting from last year we shifted our equity allocation to 15-20%.
In 2012 more than 50% of our AUM was in negotiated bank deposits. Chinese interbank interest rates were pretty high at that point – we were getting more than 6% return from deposits and sometimes close to 7% for five-year CDs. But that exposure has gone down substantially.

Q How about wealth management products?
A Last year we also started allocating to trust funds and what we call financial products – a catch-all word for anything outside equities, bonds, bank deposits and trust funds. For example, it covers wealth management products [WMPs] and other instruments issued by securities houses or insurance company-owned asset management firms.
We now put 5-10% of our AUM into WMPs [which invest in a number of different asset types, such as structured deposits, bonds and interbank loans and foreign currency].
Last year we invested a lot in these products, but the China Banking Regulatory Commission has been introducing more restrictions on them. They know this is a way for banks to get around the strict caps on bank lending, so there has been a
crackdown on that in the form of more scrutiny, more frequent inspections of balance sheets.

Q Have you put any money into Yu’E Bao or other internet finance products?
A We didn’t allocate to Yu’E Bao, but we invest in similar products. A lot of fund firms and securities houses have issued copycat products – perhaps with a bit less liquidity than Yu’E Bao, but that means they offer higher returns. They’ve proved very popular.
But product providers cannot offer guaranteed returns, apart from on bank deposits or bonds, and yet firms effectively do. They call it ‘expected return’ – but privately they do guarantee it. This is a big risk for the issuers; at some point this will cause problems for them. And if they provide guarantees but a product defaults, they will be out of the game.

Q Are you looking at investing in alternatives or foreign assets?
A We discuss allocations every quarter, and management is still very cautious on these areas. Generally speaking, we are interested in offshore investments, but they know there is a risk. We are exploring it, but it will be a while before we decide to move. Nothing has been invested overseas yet.
We do hold some foreign currency – we have US dollar and Hong Kong dollar deposits, but we haven’t invested any of them.
If we try to do any serious investments offshore, we should hire external investment consultants. A lot of US and European fund managers have come to talk to us, but we’ve not done any serious follow-up yet.
We’re still waiting for our board to make a decision on that; we’re not sure if it will be this year or next. We discuss these issues every six months; the last time was a few months ago.

Q Do you benchmark returns versus your peers?
A We don’t care too much about benchmarks. We have a very simple target return to hit every year – this year it is 6% for bonds and around 10% for property.
On the equity side we don’t have a benchmark; we just have to hit a positive return. So even if stocks are down 20%, we are expected to do that. That’s tough when shorting is limited.
Last year Zhongrong Life was one of the best performers, with a total return of 11.7%. This year we have an annualised return of 12% so far [as of mid-October].

Q Please give me more specifics on your bond allocations.
A We have 30-40% of our total asset allocation in bonds. More than 50% of that allocation is in corporate issues. We care about liquidity, so we only have a little allocated to high yield, but most is in double-A and triple-A debt.
In China, triple-A bonds are everywhere and they are very liquid; they are mostly issued by state-
owned enterprises [SOEs]. We are still very careful about investing in privately owned companies. Default on SOE bonds is virtually impossible – we still believe it won’t happen.
Double-A bond issues by private companies can return up to 8-9%, while triple-A SOE or Treasury bonds yield a little over 5%. That risk premium means private issues are attractive. But the premium has narrowed in the past two years; it is only around 2% now.
Still, there has only been one official default in China’s bond market, and we take that as an exception. So we don’t see that much difference between double-A and triple-A in terms of risk. So why not go to the higher-yield bonds? Liquidity may be slightly lower, but default risk is not much higher. Hence there’s been no flight to quality, but a flight to higher yield in China.

Q How big is your investment team, and how is it broken down by asset class?
A We have close to 30 people in the investment team, including traders, research analysts and portfolio managers. Around half of them cover equities and half bonds and other assets.

Q Do you use domestic asset managers?
A Yes, we have five or six mutual fund allocations across bond and equity products. Almost 100% of
our equities allocation was run by external managers a few years ago, but now
80% of our equity investment is done in-house.
We can do the investment and research ourselves, but we hire external managers because we need their expertise for knowledge transfer, benchmarking, to see what they’re doing and retain a relationship with them. But in fact our own performance is better than theirs.

Q How many asset managers do you use?
A We have close relationships with five or six fund houses. We have as many as 15-18 managers that we have long-term relationships with but haven’t signed contracts with.

Q Do you buy exchange-traded funds?
A Not regularly, but sometimes. The main reason we invest in ETFs is when there are rapid changes in the market, especially on the upside. They are useful if we need quick market access and need to increase our equity allocation in a single day but don’t want to move into stocks.
We would typically hold ETFs for a few days or a few weeks, and only those listed
in Shanghai.

Q Do you plan to use the Shanghai-Hong Kong Stock Connect scheme?
A We have done a lot of research around preparing for it, and we might invest next year.

Q How much are you involved with asset-liability management?
A My main responsibility is to decide on asset allocation, and that includes determining how much cash we should preserve for liabilities. I negotiate with our actuaries to determine what the risk targets are for the investment team, so that we know how much risk we can take in a single month
or quarter.