BCIC & CFA Society Boston US-China Finance Conference 2019 Summary

Problems / Concerns:

Introduction:

• Mr. Hoguet provided introductory comments by providing a background of the historical context of the current geo-political tensions between the United States and China. He stated that the since the opening of the China’s labor and financial markets to the global economic system by Richard Nixon and later China’s entry into the World Trade Organization, China’s integration in the economic system has not produced the economic liberalization which the Western architects has hoped for. Ultimately, the rise of China may be less of a partnership with the West, than a co-habitation between the two systems, and its not clear that the two systems and avoid a prisoner’s dilemma.

• Ms. Chen provided introductory comments by providing an introduction to BCIC. She stated that the BCIC is a non-profit organization and it serves as a Boston-centered platform for exchanging ideas, knowledge, and information in finance and other related subjects between the US and China. She noted the challenges to the Boston Investment Management industry, including decline margins, shift from active to passive, and job cuts across many firms. However, the wealth creation in China creates an unique opportunity for Boston firms to expand their services in a new growth market, and BCIC hopes to be a bridge between the two markets.

Potential Implications of a “Decoupling” for US Tech Industry

By Professor Yasheng Huang

Dr. Yasheng Huang provided an overview of (1) the current geopolitical tensions between the US and China, (2) how the emergence of China’s tech industry and implications of decoupling will impact the US tech industry from various perspectives, and (3) how the U.S. and China should accommodate each move forward.

1. Overview of Current Geopolitical Tensions between the US and China:

• Dr. Huang believes that the current tensions will be a long-term issue and not a short term challenge, and that its more than likely that tensions will flare up in the future from time to time. Ultimately, this a new cold war has probably arrived between China and the US, and this is good news, as its not an actual war, which actual human lives have not been lost.
• Dr. Huang stated that both sides, the US and China, need to re-think their response function in order to defuse tensions and void further escalation of the new cold war. China needs to re-think its geopolitical position and its domestic economic and political model, while the US needs to rethink how to both challenge and accommodate the rise of China in a smarter and more effective way.

2. Implication of decoupling on US Tech Industry

• Direct US Tech Industry Revenue impacts – The direct impact of decoupling could hit US Tech Company revenue by atleast $100Billion, and up to $150Billion annually. Specifically the $100B number include large companies such as Apple, Intel, Microsoft, and Qualcomm, while the $150B number includes more secondary impacts and revenue hits by HP, Dell, etc. These figures are based on the research by the investment bank, Jeffries in 2018. Currently the market is pricing in the probability of long term trade war impacts to be zero and represents downside risk to these companies. It was noted risk weighted towards more to Hardware relative to Software companies.
• Scale and Structure of R&D Expenditures in China and US – Mr. Huang noted that US research could be in relative decline compared to China, as represented by (a) Federal R&D funding has not increased for many years, (b) US Research has been increasingly dependent on international collaboration and funding, including from China, and (c) R&D Investment can be complementary between US and China, as there isn’t a large overlap between the two. As US tends to conduct fundamental research while China mostly focuses on experimental research.
• Applications of S&E Innovations – Due to each respective market, China and the U.S. have different markets which could lead to different paths of industry development in the future. China could have larger application markets for AI, materials, and renewable energy than the U.S.
• Human Capital – US technology industry is heavily dependent on human capital from China. Nearly 44% of international scholars in the US are from China, and there has been increasing co-authoring of papers between each country’s institutions.

3. How each country should accommodate each other

• Both sides should recognize each other’s position. China has to clearly work on stopping IP theft from the US, however the US should strengthen China’s position so it can implement the changes it needs in-order to stop theft.

China Reflation and EM Strategy

By Yan Wang of Alpine Macro

Mr. Wang provided broad commentary on the China and Emerging Markets in general, including: (1) Rethinking Chinese Fundamentals, (2) Ill-Conceived Deleveraging Campaign, (3) Chinese Reflation and Business Cycle, and (4) EM Strategy and Investment Opportunities.

1. Rethinking Chinese Fundamentals:

• Mr. Wang provided introductory remarks regarding how an economy’s grows in relation to the country’s capital stock, which produces higher productivity and income. Currently, China has less real output per worker relative to other industrialized countries, and China’s high investment in capital lead to higher growth.
• He addressed comments that China has chronically overspent on capital and stated that metrics to measure it, micro and macro; on a micro level, if a country overinvest, profitability should suffer, but its inline with other countries. On a macro level, corporate ROE and ROA are similar to countries.

2. Ill-Conceived Deleveraging Campaign & (3) Chinese Reflation and Business Cycle:

• Accumulation of capital stock has lead to higher debt levels and a natural consequence of the process. But deleveraging for the sake of deleveraging is not efficient, furthermore the stop-and-go deleveraging process has caused uncertainty and causes business cycle fluctuations. Recent data has shown reflation in the economy.

4. Emerging Market Strategy

• Mr. Wang provided an overview of his equity and fixed income EM allocations. Also reviewed his FX strategy, based on a blend of current account, external debt, and fx reserves.

Asset Allocation and Portfolio Construction Panel

Moderated By George Hoguet

Panelist: Sarah Samuels of NEPC, and Zhu Chao

Ms. Samuels provided introductory remarks regarding the history of the A-share and H-share of China’s equity market, including the recent inclusion and expansion of China equities within the MSCI Index. She also provided recent performance of the private markets for China investments, and the high profile growth of tech companies within the market. Based on the MSCI ACWI Index. She thinks that US based institutional portfolios should have a weighting of 5-10% of their fund allocated to China and within active management and between private and public markets. Over the next decade or so Ms. Samuels also noted that NEPC has provided substantial research efforts to China and launched initiatives to cover more strategies based in China and the greater Asia region.

Mr. Chao provided introductory comments regarding his background and insights from his work. He noted that he started his company, Asset Pro Holdings, to provided technical tools for financial advisors catering to the Mainland Chinese market, as well as their holdings outside the country. He noted the high growth of income and wealth of the Mainland Chinese market. He noted that outside China, there is over $2.2 trillion USD of assets held by Chinese investors.

Question: How do each panelist view active vs passive management?

• Ms. Samuels – There is high alpha potential for Chinese equities, and that the alpha potential could be higher than the beta, so long-short equities could make sense for the sector. Additionally that Chinese equities tend to be volatile because so much of the market is retail. So need a long-term holding period is essential for investing.
• Mr. Chao – stated that he the portfolio management community within Hong Kong is relatively small, and noted that he has seen herding mentality within fund managers, as they tend to share the same info and knowledge. He noted that investors should spend time on the ground and meet the fund managers and the companies.

Question: Privates vs Public assets for China?

• Ms. Samuels – Since the Chinese investment industry is relatively new and that there is high valuation for a lot of companies, so investors should examine prior track records carefully and examine distribution paid in capital. She also stated that since many Chinese managers tend to be new funds, many public funds can’t invest since that small fund size can’t move the needle in returns.
• He noted that Chinese investors look for Brand in the entity that they invest with rather than past performance, in-addition there is home-country bias for investors but there is knowledge and need to diversify. Big brands is preferred over mid-size and lessor known quality firms.

Fundamental vs Quantitative

Moderated By Lillian Qin

Panelist: Steve Xia of Guardian Life, Bin Shi of Acadian Asset Management, and Rohit Shrivastava of Panagora Asset Management

Ms. Qin started with a quick fire Q&A:

Question: What is the 1 year forward CNY/USD rate?

Bin: 7.3; Xia 7.5; Shrivastava 7.5

Question: What is China’s 1yr GDP?

Bin: 6%; Xia 6.1%; Shrivastava no more than 6.3%

Question: Trade deal by 2020?

Bin: Step-by-step partial; Xia Partial trade deal; Shrivastava partial trade deal

Question: Review investment style for China?

• Bin: Quant-fundamental, have a macro view, then focus on fundamental and company’s fundamentals, then seek high quality assets. Additionally, need diversification due to the lack of diversification in the Chinese market, as tech and financial are the largest weight in the A-shares
• Rohit: Seek attractive valuations, avoid bad quality, quality earnings, and good momentum, as the market is really retail. As the weight of China in MSCI increase, China will have a bigger outcome on financial markets which means that it could be less correlated with other markets.
• Xia: Also, a mix of macro and fundamentals. Stated that momentum signal and market view are extremely important since the market is driven by a lot of news flow.

Question: How do you analyze Chinese companies given that they’re not based on GAAP accounting?

• Bin: Chinese companies since 2005/6 actually adapted accounting standards very similar to IFRS and is 90-95% similar.
• Robit: Since there are differences in earning quality, investors should diversify the sources of information.
• Xia: Since accounting information is different, that means models used for western companies can’t be as useful, so investors should instead look deeper into fundamentals such as the value chain, and company exposures, etc.

Question: How is ESG incorporated in investing in China?

• Bin: He noted that his firm has been a pioneer in ESG and has incorporated ESG in the process of analyzing Chinese companies.
• Robit: Believes that ESG is incorporated at his firm
• Xia: Believes that ESG has to be a long term perspective, and that investors with a 6 month holding period might have less interest in ESG than a long term investor

Question: How does the trade war impact the decision to invest in Chinese stocks?

• Bin: Temporary impact on Chinese stocks
• Robit: Also believes it’s a temporary impact
• Xia: Additionally a temporary impact

Question: Will China escape the middle-income trap for China and which companies could benefit?

• Bin: Chinese spending will create opportunity for healthcare and consumer companies
• Robit: Not sure, but sees continued growth for China which will create opportunities
• Xia: Ultimately will benefit the consumer and seen the expansion of Chinese consumers and see opportunity in downstream sectors such as financials and consumers discretionary, and healthcare.