Managing Investment Risk in Chinese Assets

An expert panel hosted by the Council of Institutional Investors discussed some of the unique risks in investing in China and advised taking an active approach to a portfolio with China exposure, rather than a passive one. This advice is critical for retirement plans that may offer an emerging market fund option in their plan menus.

The panel featured Charles Nguyen, managing director of Asia ESG investing at Neuberger Berman; Peter Harrell, former senior director for international economics and competitiveness on the National Security Council; and Scott Moore, director of China programs and strategic initiatives at the University of Pennsylvania.

China offers some unique investment opportunities and risks. One on hand, it has provided faster growth than many other markets in the last few decades, but as all three members of the panel highlighted, China has a political relationship with the U.S. that makes investing there riskier. The risks identified by the panel included: a conflict over Taiwan, increased export controls on sensitive technologies and other forms of economic restriction.

Nguyen said there is “recency bias” concerning news about China, meaning one tends to privilege the recent bad news, such the spy balloon, in a total evaluation of the investment risk.

However, he strongly recommended not investing in a passive “broad index” when it comes to emerging market funds with exposure to Chinese assets. Instead, Nguyen recommended taking an active, “human-judgement approach.” EMFs should be customized to avoid some of China’s unique risks and actively managed to move away from problematic assets should new risks develop over time.

An actively managed fund can adapt more easily to a changing regulatory environment and change fund assets to reduce both regulatory risk from export controls and reputational risk from human rights transgressions.

Harrel noted that there is some risk in partnering with firms based in China that are affiliated with the Chinese military or which do business in the province of Xinjiang, both of which are subjects of interest for U.S. sanctions and export controls policy.

The U.S. is also exploring export controls in specific sectors, such as data and biotech. Harrell said that the Chinese health care industry is an interesting example, because though U.S. sanctions policy normally exempts medicine and medical devices from sanctions, export controls on innovations in biotech could slow growth in that sector and reduce investment opportunities.

Moore agreed that the Commerce Department has biotech exports “in their crosshairs.” He said that “barriers to technology transfer” will also limit the growth of Chinese tech firms.

Despite these risks, however, panel members were still optimistic about investing in China. They noted that China and the U.S. still have a massive trade volume between each other.

There are also growing people-to-people connections between the two countries. For example, all three panelists noted the thousands of Chinese students who study in American universities.