Portfolios are becoming political
First it was ESG. Now watch out for the China backlash
Despite my hopes for spicy, under-the-radar reveals, it’s been a quiet week for fund news. To be fair, November 2024 does feel a long way away.
All the same, the US elections are coming up. A month ahead of the Iowa caucuses, Trump remains the frontrunner Republican candidate. He is primed for a trade war:
While his main target remains Beijing, Trump has hinted at confronting European nations over taxes on software, online subscriptions and other digital services.
That investing in, say, China, would incur more political risk in 2024 is obvious. What this slow news week helped surface is, investing is about to become politicised.
A report published this week by Future Union, a bipartisan organisation, took issue with the fact that US-based pension funds have invested over $68 billion in China in the past 36 months. It shows that public pension funds in 43 states have investments in China and Hong Kong.
When asked to respond, the two largest US public endowments basically said: "Well, why wouldn't we invest in China? It's the world’s second-largest economy." Except, that's not all they’ve said:
CalPERs also said it was:
“Closely monitoring discussions in Washington and elsewhere and, as always, will comply with any additional government requirements that might be initiated.”
And CalSTRS said:
“We are in full compliance with President Biden’s executive order...our exposure is modest...and falling.”
You’d be right to ask, did they even need to say the second part? Don’t these huge pension funds follow laws and regulations?
Of course they do. But also, their investments just became political. The way it works was perfected with the ESG backlash:
If ESG investing is generating terrific returns, it's harder to be against. Not impossible, just harder. If returns falter, though, arguments can be made that the do-gooding stands in conflict with the investing.
Maybe you are compromising fiducial duties? Not good! Maybe you are in violation of anti-trust laws? Also not good! These arguments (and others) all emanate from a single origin, that an investment choice isn’t merely unsuccessful, but is politically motivated. Doubly so when the do-gooding itself is being questioned.
As long as the upside was promising, investing in China was just plain investing. But when the upside is not quite there, it sets the stage for a narrative of conflict: investment priorities versus a political choice.
Asset managers have struggled to make it big in China, and not for lack of trying. In 2022, there were 159 fund managers in China, 58 of which were state-owned, according to data from the Asset Management Association of China. Of the 53 that were privately held, 45 were joint ventures established by foreign asset managers and their local partners.
In the main, the joint ventures haven't delivered the gains managers were hoping for. A mix of issues around governance, sustainability and intellectual property tends to manifest.
As early as March this year, a rumor suggested Vanguard intends to pull out of China; in October, Vanguard confirmed the plan to sell its JV stake to its partner, Ant Financial. Others may soon follow. But now the decision on whether to stay or leave won’t be merely an investment decision, it’ll be a political statement as well.
That’s why US endowments found themselves defending their (not so big) investments in Chinese equities. We will see more of that in the coming year. Certainly on China, but elsewhere too.
In 2024, investing in almost anything may run the risk of becoming a political issue.
Treasure Corner
I like that the media is paying attention to research on the business of asset management. This is, after all, what this entire newsletter is about.
To my delight, ETF Stream has rounded up what they felt were the five most important academic papers on ETFs this year. Let's quickly recap what they chose:
1. Active managers engage in ‘hopeful fantasising’ over decline: Researchers argue that instead of proactively finding solutions for their falling market share, active managers resort to unhelpful tactics such as 'asserting a strong identity, delegitimising others, and framing a practice as inaccessible'.
2. The rise of ETFs is damaging future returns: The paper analysed the effects of indexing on asset prices and the welfare of investors. The author summed it up:
“While the availability of index funds allows small investors to enjoy market returns, at equilibrium, these market returns are lower than those that were enjoyed by investors before index funds became available.”
3. ‘ETF bubble’ is a ghost story, pricing inefficiency is not: The growth of passives between 2000 and 2017 was not responsible for inflating market prices, as other academics have claimed. However, the research finds evidence that passives did increase volatility in markets, while also decreasing the impact of new information being priced in.
4. BlackRock, Vanguard and State Street rely on ‘millennial marketing’ to enhance market share: I'm not sure 'millennial marketing' is a thing? Anyway, the research argues that instead of acting as agents on behalf of investors, the ‘Big Three’ (BlackRock, Vanguard and SSGA) either vote with management or “opportunistically” to increase their market share.
5. How many factors should investors take seriously? Studying 153 US equity factors, the research found just 15 factors are needed to capture all available alpha.
Also happening
Major banks worldwide have cut over 60,000 jobs this year. Banks point to reduced fees (because of fewer lPOs and muted dealmaking) as the reason. But...13,000 of those job cuts were in UBS following the Credit-Suisse takeover, and another 12,000 were cut at Wells Fargo. Are jobs being lost because of markets, or because the industry is consolidating and chasing efficiencies?
Japanese banks are racing to beef up their asset management business. Historically, Japanese households prefer holding cash, but the government is worried about inflation. Other than offering tax incentives, it’s prodding domestic banks to sell more aggressively.
Already, Japanese asset managers have been relatively resilient to outflows. In 2022, they saw a 5.5% decrease in assets, compared with 14.2% for north American managers, and 16.8% for European managers.
Gapminder's 100 positive news stories from 2023. It's harder to stay attuned to the good things that happened this year, and therefore easy to believe nothing good happened at all. The list of positive stories spans topics that include: health, energy transition, women, standard of living, nature and space - all issues that overlap with dominant investment themes.
Happy New Year!