What “smart money” knows about the Evergrande crisis in China


In all of its original howling capitalization, this line from “Adventures in the Screen Trade”, William Goldman’s 1983 book on Hollywood, sums up the fiasco of the China Evergrande group and global investors caught in its collapse.

As the late Mr. Goldman did in his book, I will repeat the phrase to soak it up.

NOBODY KNOWS ANYTHING, because Chinese companies and their investors are held hostage to the whims of Xi Jinping, who is in fact the country’s life president. Executives, businesses, and entire industries once favored by Xi and the ruling Communist Party have been stripped of their power and value without warning, making foreign investors look like fools.

And NOBODY KNOWS ANYTHING, because even if professional investors – so called smart money – had particular insight into what the Chinese government was going to do next, they would hardly be able to act on it. result. If they did, it might lower your risk, but it would almost certainly increase theirs.

Because NOBODY KNOWS ANYTHING, investors need to be confident that they are comfortable with their exposure to China.

On Wall Street, the hype almost always leads to heartbreak, and the experience of people who have jumped on the bandwagon to invest in China has so far been no exception.

U.S. mutual funds and exchange-traded funds investing primarily in China held $ 43 billion in net assets at the end of August, up 44% from 12 months earlier, according to Morningstar. During this period, investors added approximately $ 13 billion in new money.

More than a quarter of the total assets of these funds came in in the last year alone, just in time for a long march of losses. Since its peak in February, the MSCI China Index has lost 30%.

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What about the longer term?

Between its creation at the end of 1992 and August 31, the MSCI China stock market index returned on average 2.2% per year, including dividends. Over the same period, the MSCI Emerging Markets index grew by 7.8% per year; the S&P 500, 10.7%.

This covers a period of almost 30 years during which the Chinese economy has often grown by at least 10% per year. Still, you would have gotten much better returns on US Treasuries than on Chinese stocks. Maybe China, which holds over $ 1 trillion in US Treasuries, knew something Wall Street didn’t.

And knowing what the Chinese government thinks is harder than ever.

Late last year, as reported by my colleagues Jing Yang and Lingling Wei, President Xi personally intervened to block the initial public offering of Ant Group Co., shortly before the financial company could not launch what would have been the largest IPO in history.

Since then, the government has condemned Alibaba Group Holding Ltd. with a $ 2.8 billion antitrust fine that state media called “also some kind of love.” in July, shares of New Oriental Education & Technology Group Inc. and TAL Education Group fell about 70% in two days after Communist Party authorities issued an edict that would force tutoring services for children to be run like no Businesses themselves never saw it coming, and Wall Street analysts have been gleefully touting stocks.

In the latest incident, real estate developer China Evergrande is on the verge of collapsing under the enormous burden of its debt; it is only recently that the Chinese authorities have stopped flooding the housing market with cheap loans.

Many analysts, commentators and investors are calling China’s recent actions “regulatory crackdown.”

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That’s not what’s happening, however, says Andrew Foster, chief investment officer at Seafarer Capital Partners LLC, a global asset manager in Larkspur, California.

“These are not regulatory events,” he says. “These are political interventions to reshape Chinese society, guided by Xi’s personal agenda, aimed at achieving goals that are not always known.”

Because this program is fluid, opaque and unpredictable, said Mr. Foster, “investors should be very careful not to rely on past experience when forming expectations about future investment results. . Seafarer invests in China, but its main fund only owns about 20%. of its assets there.

This is significantly lower than the major benchmarks that track emerging market equities, where China accounted for 34 to 37% of total capitalization at the end of August.

Most fund managers won’t deviate much from these cues, and here’s why.

They don’t want to be what investor Mark Kritzman calls “bad and lonely”. together gives each manager a plausible denial.

But a company that owns little or no Chinese stocks will be blamed by customers if China experiences a boom, as its funds will lag behind their competitors. Getting it wrong and being alone is what gets asset managers fired.

So NO ONE KNOWS ANYTHING because most investment firms, whether passively following a benchmark or actively picking stocks, have chosen to echo China’s weightings in major stock indexes, no matter what. he is coming.

This helps explain why major fund managers continue to urge investors to invest more money in China, underlining its potential while downplaying its past disappointments and worrying current policies.

“Index providers say they don’t tell people how to invest, and fund managers say they have to follow benchmarks, so it’s this endless circle where no one takes responsibility,” says Perth Tolle, founder of Life + Liberty Indexes and creator. from Freedom 100 Emerging Markets, an exchange-traded fund that does not own any shares in China. “Wall Street is going to twist logic and do mental gymnastics,” she said, “but it’s the investors who end up getting hurt.”

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In my opinion, Wall Street’s belief that Beijing is about to move towards free capital markets is based on shaky evidence.

Chinese governments have been interfering in the stock market since the 19th century. Time and time again, the authorities have inflated bubbles with cheap credit, placed government officials on boards of directors, micromanaged day-to-day operations, and undermined the rights of outside shareholders. Even in the early years of communism under Mao Zedong, the government ruled, and ultimately destroyed, several stock markets.

Today, China accounts for about 4% of the total value in the MSCI ACWI Index of 50 developed and emerging markets around the world. In theory, an investor should have as much China, but no more, in a global equity portfolio. If, for example, you hold 10% of your assets in an emerging markets fund which, in turn, holds a third of its holdings in China, then you are considering a total exposure of around 3%.

Until Beijing stops using the stock market as a toy, that’s more than enough. Anyone who tells you that you need to invest more than just a treat in China is asking you to bet that the future will be nothing like the past.

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