China is in the midst of opening its markets to global investors while encouraging local investment abroad. In the following interview, Eric Mogelof, LukeSpajic, Haining Yin and Isaac Meng discuss the progress so far and what these developments mean for investors.
Q: Why are investors increasingly focused on China?
Eric Mogelof:It is no secret that China has become a critical part of the global economy. Long important in international trade, China also now stands as the world’slargest economy in purchasing-power parity terms and meaningfully affects global growth, inflation and debt dynamics.
In addition, China’s economy is growing in accessibility to investors. Beijing continues to actively explore avenues to open its capital accountto offshore investors, and the toolkit of financial instruments available to investors in China continues to grow.
Accordingly, PIMCO sees China-based investments as an increasingly important part of investor portfolios, migrating from tactical allocations – oftenwithin broader equity or fixed income strategies – to strategic allocations, and we have assembled a broad team specifically focused on China to make thisincreasingly important market accessible to our clients.
Q: What is PIMCO’s assessment of the macro climate in China?
Isaac Meng:PIMCO has consistently held below-consensus views on China’s growth prospects, and we continue to do so. Chinese officials themselves now refer to a “NewNormal” for the Chinese economy of “around” 7% growth, and we continue to think that GDP growth in China will fall short of that. For 2015 we see growth inthe low 6% territory, with mild disinflationary pressures emerging. Indeed, China is dealing with a property slowdown and deleveraging of the shadowbanking system, and can no longer rely on low wages and a competitive currency to support an endless export boom.
The People’s Bank of China (PBOC) has begun to ease rates and reserve requirements, aiming for a soft landing, and we expect more intensified easing to follow,including potential balance sheet expansion. In terms of the currency, while there is a risk that China could enter a currency war and engineer acompetitive devaluation of the yuan, this scenario is unlikely in our view for two reasons: First, Chinese officials seem genuine in their desire totransition to a more domestic-consumption-based growth model; second, they continue to aspire to global reserve currency status for the yuan.
Q: What are Chinese policymakers’ strategic objectives for China’s financial markets?
Haining Yin:The macro picture in China sets a critical stage for policymakers to accelerate the government’s structural reform agenda, an important part of which is todeepen domestic financial markets. After a decade of strong economic growth, China needs more efficient financial intermediation to deploy excess savingsback into the real economy. That requires an effective market for capital allocation, sophisticated domestic investors and more participation from globalinstitutions.
So China will continue to move towards opening the capital account and making the yuan a convertible global currency. We also expect China’s fixed incomemarket, which now consists primarily of government and corporate bonds, to develop other sectors and instruments, offering additional opportunities forglobal investors to gain exposure to China.
Q: What avenues are available to global investors seeking access to China’s markets?
Mogelof: The Chinese government is continuously exploring options for global investors to gain greater access to the Chinese equity and debt markets. This efforthas historically centered on the offshore Chinese markets, including “H” shares ‒ Chinese companies traded on the Hong Kong Stock Exchange – as well as dimsum bonds ‒ yuan-denominated bonds issued outside of China.
While the offshore markets remain heavily traded, Chinese policymakers and global investors are increasingly focusing on the onshore markets aswell. China is providing access to its onshore capital account in four key ways:
- Through the “Qualified Foreign Institutional Investor” (QFII) and the “Renminbi Qualified Foreign Institutional Investor” (RQFII) programs;
- By granting direct yuan investment quotas;
- By connecting onshore and offshore stock exchanges (e.g., Shanghai-Hong Kong Stock Connect); and
- Through bilateral arrangements, such as the Hong Kong mutual recognition initiative (under consideration).
Q: To what extent is PIMCO participating in these programs, and how do we see them evolving?
Yin:PIMCO participates in the QFII program and has applied to participate in the RQFII program. The assets purchased through these quotas are deployed onbehalf of our investors in a variety of ways, including within PIMCO’s global bond, Asia local bond and global asset allocation strategies. Notably, wecontinue to hear interest from clients in a dedicated China strategy, which would allow global investors to access these assets while potentiallybenefiting from PIMCO’s active management.
Mogelof: In terms of the Stock Connect, PIMCO’s Singapore equity trading desk is set up to access products referencing Shanghai-Hong Kong Stock Connect shares, andaims to begin direct investing in eligible shares listed on the Shanghai Stock Exchange for our mutual funds in the near future.
Finally, PIMCO sees a distinct possibility that bilateral programs could be extended to other countries or regulatory regimes, including UCITS,(Undertakings for Collective Investments in Transferable Securities) over the secular horizon. So, down the road, we see a strong possibility that PIMCOsolutions could be delivered through these vehicles.
Meng: In addition to these onshore opportunities, we actively use offshore interest rate trading instruments to express our China macro views and will continueto do so.
Q: What are PIMCO’s highest-conviction China investment strategies? Where do we see the greatest value for our investors?
Luke Spajic:With the opening up of Chinese onshore markets, there are four key factors that investors will look at: liquidity, value, diversification and the currency.
Local China markets, despite their massive size, do not yet offer the level of liquidity that full engagement with the global marketswould necessitate. For now, liquidity availability will evolve at the pace dictated by regulators; however, this pace is quickening. That’s why thearchitecture we’ve discussed and its build-out are so important.
In our view, the value proposition is clear given the high real rates on offer. We see value in buying government bonds, as well as quasi-sovereign andbank debt. The local yield curves across these asset classes are quite flat. The five-to-seven-year part of the government curve, at 3.3% on average,offers more value per unit of duration than the 10-year at 3.4%. In credit markets, we find value in shorter-dated bank paper – for instance, one-yearcertificates of deposit in solid Chinese banks.
We also hold a favorable view on Chinese equities, which we have expressed in both dedicated emerging market equity portfolios and our global assetallocation investments.
On diversification, as Eric mentioned, we think it’s only a matter of time before China’s worldwide economic footprint translates into global fixed incomeinvestors owning more Chinese assets, especially with developed markets offering such low yields in comparison.
It’s important to note that our local rate and credit market views on China are predicated on currency stability, which reduces volatility and uncertaintyfor investors. Our strong currency view is both a key call and a key factor in anchoring our real rate expectations.
Q: How do you see the local Chinese investor base evolving in the next two to three years?
Yin:As China continues to build wealth and increase its global economic presence, the number of sophisticated Chinese investors, both institutions andindividuals, grows daily. These investors are increasingly tapping into the global markets for both tactical (alpha) and strategic (diversification)investments, and policies are increasingly accommodative for this outbound investment. Indeed, the government has tailored several programs for qualifieddomestic investors at the institutional level (QDII), the enterprise level (QDIE), the limited-partner level (QDLP) and, potentially, the individualinvestor level (QDII2).
PIMCO has been working with Chinese investors for over a decade. We aim to deepen our partnerships with Chinese institutions to provide solutions acrossglobal markets and asset classes; we will also continue to evaluate opportunities to partner with wealth management investors to help provide access toglobal investment opportunities.
Q: Any concluding thoughts?Mogelof:
Broadly, we expect the flow of investments to increase both into and out of China. We will continue to strive to provide top-quality investment solutionsto China investors as they look globally and to global investors as they evaluate this important and growing market.