China is slated to become one of the world’s largest cross-border investors by 2020, with an estimated $20 Tn of global offshore assets, according to research firm Rhodium Group and Mercator Institute for China Studies. Wealthy Chinese investors are also increasingly looking abroad for new investment opportunities, highlighted by recent reports of China’s investments in Africa and buyout of global real estate properties.
While Chinese investments in Africa and real estate properties continue to grow, here are five reasons why Chinese investors should consider investing in U.S. asset managers.
1. Volatility in China’s Domestic Stock Market
January 2016 was a rocky start for Chinese investors when the Shanghai Composite Index plunged by 7%, forcing Chinese officials to halt trading. The last time the Chinese stock market crashed was in June 2015, when $700bn of value was lost in Chinese stocks in one single day.
As shown in the below graph, the Shanghai Stock Exchange continues to drop and has been showing signs of continuous market volatility since June 2015.
In addition, the below graph is a snapshot of Chinese stock market activity over the past 7 years from 2008 to 2015. The 2008 global financial crisis affected the Chinese stock market, and is a reminder of the importance of portfolio diversification should there be another economic slowdown. Therefore, without the ability to invest elsewhere, recent volatility demonstrates risk for Chinese investors.
2. USD/CNY Currency Divergence
While historically there has been a strong relationship between the USD and CNY, domestic Chinese economic expectations have recently spurred governmental action in devaluing the renminbi. While China remains the world’s second-largest economy, there is growing fear that China’s economy is showing signs of a slowdown. As an effort to spur the economy, the Chinese government has been allowing the renminbi currency to steadily decline and devalue against the USD, resulting in a boost in Chinese exports.
This USD/CNY divergence may be temporarily beneficial for Chinese exporters who can now sell their goods at a cheaper price compared to their competitors. Chinese investors can also take advantage of this currency divergence by investing in U.S. asset managers when the dollar is stronger than the renminbi . There are several reasons why Chinese investors should invest when the USD dollar is strong. Below are some of the top reasons:
- A stronger USD provides the dollar with more purchasing power against other currencies, allowing the dollar to buy more units/currencies abroad. A stronger dollar means it takes fewer dollars to buy specific commodities.
- However, a large divergence between USD/CNY also makes it more expensive for China to purchase U.S. imported goods due to the dollar’s stronger buying power. Therefore, investing in U.S. asset managers and the USD allows Chinese investors to protect themselves to a certain extent.
- A stronger dollar also makes U.S. investments more attractive to Chinese investors as they can enhance returns when those assets and returns are eventually converted back to their home market.
3. Portfolio Optimization and Diversification
Sophisticated investors agree that diversification across asset classes as well as geography is required for portfolio optimization. Chinese investors can achieve portfolio diversification by accessing and investing in illiquid alternative investments such as U.S. hedge funds, private equity, venture capital, and more. Since alternative investments are non-traditional investments as opposed to stocks and bonds, they do not tend to move in the direction of the public markets. For instance, hedge funds can invest across various markets using a wide array of instruments. These investments can be insulated from market fluctuations and their return streams can be different than that of public markets.
In addition, according to a 2015 study by Towers Watson, assets under management for North American asset managers were at USD $44.5 Tn at the end of 2014, an increase of 5.8% from the previous year. As a point of comparison, assets under management for European firms were at USD $25.9 Tn, a 1.5% decrease from the year prior. The below chart from the study shows the distribution of assets by country over the last 10 years. One key takeaway is that there has been an increase in the representation of U.S. asset managers, while European and Japanese asset managers have lost market share during this period.
Whether it’s through hedge funds, private equity, or venture capital, U.S. asset managers can provide portfolio diversification for Chinese investors.
4. Positive U.S. Expectations and Outlook
The U.S. Federal Reserve raised its interest rate by 0.25% in December 2015. The Fed’s first rate hike in nearly 10 years sends a strong signal, a demonstration of strength and confidence in the U.S. economy. Strengthening the dollar is also a signal that the U.S. central bank has the ability to handle higher borrowing costs. Coupled with the recent jobs report that showed increasing rates of employment, the U.S. is showing signs of a growing economic outlook.
5. China’s State Council Approves Qualified Domestic Individual Investor Program (“QDII2”)
In October 2015, the Chinese government approved the Qualified Domestic Individual Investor Program, or QDII2, taking a significant step towards removing restrictions for Chinese investors. Under QDII2, investors who are residents in one of the approved zones and who have at least RMB 1,000,000 in financial assets will be subject to relaxed currency conversion restrictions, and will be able to make direct offshore investments. This provides Chinese investors the ability to diversify their portfolio risks with offshore investments.
Given the diverse investment opportunities, strengthening economy, global leadership, and top education institutions, the U.S. is an opportune place for Chinese investors. Investments in U.S. asset managers will allow Chinese investors to gain access to new investment vehicles that provide portfolio diversification and optimization. Provided economic and regulatory shifts occur as expected, now is an opportune time for Chinese investors to seriously consider investing in U.S. asset managers.
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