China, once a beacon for investors, is facing unprecedented challenges, leaving institutional portfolio managers worldwide questioning its investability. ‘A valid concern, but the question whether or not China is still investable is too complex for a simple yes or no.’
That’s according to Arthur Kroeber, founder of Gavekal Dragonomics, an independent research firm specializing in the economics, politics, and social issues of China.
A trifecta of challenges— a faltering Chinese economy, persistent geopolitical tensions, and unpredictable regulatory shifts—has induced caution among investors in Chinese assets.
The Shanghai stock market has seen a decline of over two percent this year, while Shenzhen plummeted by more than 10 percent. Hong Kong, a usual gateway for foreign investors to access China, witnessed a substantial 11 percent drop.
Kroeber emphasizes that economic growth is hindered by both a weak recovery after easing Covid restrictions and structural challenges resulting from an economic strategy historically relying too much on real estate, high local debts, and inefficient state-owned enterprises.
‘At the moment, the Chinese government is more focused on national security and technological self-sufficiency than on economic growth. That shift is truly significant,’ says Kroeber, who has been living and working in both New York and Beijing since the 1990s.
Taiwan
Nevertheless, the most pressing risk is Beijing’s position regarding the Taiwan issue, says Kroeber, which was confirmed by President Xi Jinping during the international summit in San Francisco last Wednesday.
During their four-hour meeting, Xi emphasized to his American counterpart Joe Biden that Taiwan is the most urgent and dangerous issue in U.S.-China relations, as reported by a senior U.S. official to Reuters reporters. The official quoted Xi, stating that China prefers a peaceful “reunification” with Taiwan, the island claimed by China. Xi also mentioned the conditions under which violence could be used.
Frozen assets
In the event of a conflict between China and Taiwan, what investors are most afraid of are ‘frozen assets’, reminiscent of the scenario following the Russian invasion of Ukraine. Kroeber warns that investors with substantial stakes could face significant losses, dismissing any illusions of preserving liquid assets amid persistent geopolitical tensions.
‘They will likely lose much, if not all, of their money,’ Kroeber says. ‘Repatriating money to Europe or America is not a feasible option then, as we have seen with frozen assets in Russia,’ says Kroeber.
Private equity parties are also not spared from the uncertainty. According to Kroeber, the risk associated with long-term investments in Chinese private equity is substantial. He illustrates this with the example of pension funds and U.S. endowments that have dedicated significant portions of their portfolios to Chinese private investments.
‘How certain are parties putting their clients’ money into China for 10 years that their assets won’t freeze due to a war with Taiwan? Well, not very certain.’
Despite generous returns over the past decade, China-focused private equity and venture capital funds had an average annual return of -5.6 percent in 2022, according to the South China Morning Post, citing data from data provider Burgiss.
These lower returns have led to significant difficulties in attracting capital: according to industry data, global fund managers focusing on China raised only 5.6 billion dollars in September of this year, a decrease of over 70 percent compared to 2022.
Investors who still want to invest in China, according to Kroeber, are best advised to focus on sectors less sensitive to geopolitical tensions and the whims of the Chinese government, such as the pharmaceutical industry and green energy.
‘Investing in high-tech is also still interesting for many investors because you are relatively safe from interventions by the Chinese government in that sector. Of course, there is always a chance of sanctions from the U.S. As long as you avoid sectors like semiconductors and AI, you are likely safe in high-tech. It is easy for the U.S. government to restrict the import of chips and AI-related products in the interest of national security.’
One of the voices tempering the rhetoric about the risk of war is U.S. General Charles Brown, the highest military official in the U.S. ‘I don’t think Xi Jinping really wants to take Taiwan by force. He will try to do this in other ways,’ said Brown.