The Case for Active Investing in China

Passive fund giant Vanguard has chosen China to go active. Why?

Kate Lin, CAIA 03 January, 2022 | 16:19
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Kate Lin: Welcome to Morningstar. Passive fund giant Vanguard has chosen China to go active. Why? We are talking to Claire Liang, Senior Analyst for Morningstar Manager Research, today. Hi, Claire.

 

Claire Liang: Hi, Kate.

 

Lin: Vanguard says China's vast but inefficient market offers opportunity for active managers to generate alpha. Is this true?

 

Liang: Yes. I think China's equity market is ideal for active fund managers given that it is less efficient than the developed markets, especially the onshore China A share market, which presents a lot of alpha opportunity. We did the latest China active/passive barometer in May this year, which measures the performance of onshore China domiciled active funds against their passive peers in their respective Morningstar categories. And one of the key findings is that 76% of active diversified stock-heavy funds survived and outperformed their average passive peers during the trailing 10-year period through December 2020.

 

I think one of the reasons for that is the market is retail driven. There is a high level of participation from retail investors who are generally less focused on company fundamentals, and they account for around 80% of the average daily trading volume of the onshore market. So, this creates mispricing opportunities for more sophisticated and well-resourced investors who has the ability to do proper due diligence. The breadth and depth of the China equity market also allows active fund managers to add value through stock picking.

 

Lin: I see. Other than onshore stocks, the Vanguard fund is going to invest in offshore securities. What does it mean for investors?

 

Liang: Well, investing in both onshore and offshore China equities, or an all-China approach we call, can provide investors a broader opportunity set. Both the onshore and offshore markets have their unique investment universe that are only available on their respective exchanges and not listed elsewhere, such as the Chinese liquor companies for China A shares or the internet giants for official China equities. So, adopting an all-China approach can allow active fund managers to capture the best investment opportunities that China has to offer regardless of listing locations.

 

Lin: So, will there be any diversification benefits investing this way?

 

Liang: Yes, you are right. So, there can be some diversification benefits, given the different market dynamics between the onshore and offshore China equities. So, this year is actually a good example where the onshore and offshore China equities performed quite differently. That being said, Chinese equities are still subject to some common factors such as China macroenvironment and government policies, no matter where it's listed. So, the correlation between the A shares and offshore-listed Chinese equities will be higher than, let's say, the correlation between China A shares and U.S. equities. So, from a diversification perspective, an all-China strategy is still best suited as a supplementing role within a broad portfolio.

 

Lin: Right. So, finally, in your experience, in what ways are offshore fund providers better or worse than onshore providers?

 

Liang: Well, offshore or global fund managers, they are generally more experienced than domestic China fund managers. Many of them have gone through multiple market cycles and they have formed a structured and disciplined investment approach. On the other hand, the domestic China fund managers can be more familiar with the China A shares, which is their home market. So, this allows them to invest across the full market spectrum and to capture alpha opportunities yet in less known companies.

 

Lin: Perfect. Thank you so much, Claire. From Morningstar, I'm Kate Lin.

 

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About Author

Kate Lin, CAIA

Kate Lin, CAIA  is a Data Journalist for Morningstar Asia, and is based in Hong Kong

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