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Hong Kong Feels the Impact as Foreign Investors Vacate China

Long-term skepticism of the China market, plus the "mainlandization" of Hong Kong, are seeing tens of billions leave the city
Published: January 25, 2024
People gather at East Coast Park Precinct as city's skyline is seen during the dusk in Hong Kong on December 20, 2022. (Image: PHILIP FONG/AFP via Getty Images)

Major U.S. and other international financial movers are quietly withdrawing from the risky Chinese market, including divesting $68 billion in foreign capital from Hong Kong.

Global funds are reducing their investments in China, affecting Hong Kong. According to a Bloomberg analysis of reports on holdings from 14 U.S. pension funds with assets exceeding $500 million and invested in Chinese stocks, most retirement funds have been gradually divesting from Chinese stocks since 2020.

Among them, major U.S. pension investors, such as the California Public Employees’ Retirement System (CalPERS) and the New York State Common Retirement Fund, have cut their investments in the Chinese market for the third consecutive year.

Some funds are exiting the Chinese market entirely. Last December, the Missouri State Employees’ Retirement System requested its employees to withdraw all global public equity investments currently in China.

Long-term skepticism

Initially, the exit of these mainstream funds was attributed to performance issues. However, considering increasing skepticism about China’s long-term economic issues, the vulnerability of the Chinese real estate industry, and the worsening U.S.-China strategic competition, the current trend may evolve into a structural shift. Some large pension fund managers in the U.S. and Australia have also expressed caution about mainstream strategies in China.

Facing escalating geopolitical risks and the sluggish recovery of the world’s second-largest economy since the pandemic, global investors’ demand for funds that exclude China is growing.

Gary Dugan, Chief Investment Officer at Dalma Capital Management Ltd., told Bloomberg that he would reset the benchmark to Morgan Stanley Capital International (MSCI) indices excluding China. This would allow foreign investors to exclude China from their investment portfolios without worry.

Chris Ailman, Chief Investment Officer of the California State Teachers Retirement System (CalSTRS), stated in an interview that China is a topic frequently discussed by U.S. and global chief information officers.

He said that some companies have halved the index weight to reduce risk exposure, while others have removed China from emerging market indices. The change brought about by CalSTRS is not an increase or decrease but a change in index weight.

It is noteworthy that in this situation, Hong Kong, which relies on mainland China, finds it difficult to stand alone. A month ago, the U.S. Federal Retirement Thrift Investment Board (FRTIB) announced that it would adjust the benchmark index for its international funds in 2024 in response to escalating geopolitical risks. This move would mean the exclusion of indices listing Hong Kong-listed stocks.

On Nov. 14, the FRTIB, which manages $770.5 billion, said in a statement that, after a routine review of the Thrift Savings Plan (TSP), it decided to change the benchmark for its International Stock Index Investment Fund (I Fund), excluding up to $68 billion in investments in the Hong Kong market from its $680 billion international fund.

FRTIB made this decision based on the recommendations of its investment adviser, Aon Corporation, a global professional services and management consulting firm, and FRTIB staff. The report indicated that Washington’s increased investment restrictions on China were the primary reason for this decision.

According to the statement, FRTIB, which manages retirement savings accounts for nearly 6.9 million people, said the I Fund would transition from the MSCI Europe, Australasia, and Far East Index to the MSCI All Country World ex-U.S. Investable Market Index (excluding the U.S., China, and Hong Kong). This adjustment would more than double the number of countries included in the I Fund.

FRTIB cited Aon Corporation as saying that if the current investment restrictions on China mark the beginning of further restrictions on China and Hong Kong, the level of uncertainty may outweigh the benefits of expanding the I Fund to include China while retaining benefits for Hong Kong.”

Hong Kong’s ‘mainlandization’

Hong Kong, closely connected to the Greater Bay Area, is experiencing “mainlandization” in the wake of the “National Security Law” imposed on the city by the Chinese Communist Party (CCP) in mid-2020. On Jan. 11, Zheng Yanxiong, Director of the Liaison Office of the Central People’s Government in Hong Kong, went to Guangzhou to meet with Huang Kunming, Secretary of the Guangdong Provincial Party Committee, and Wang Weizhong, Deputy Secretary of the Provincial Party Committee and Governor.

Huang Kunming stated that during the inspection of Guangdong by the Chinese Communist Party leader Xi Jinping last year, the positioning of the Guangdong-Hong Kong-Macao Greater Bay Area as a “focus with two places” was redefined. He also expressed hope that the Liaison Office will continue to “guide and support” Guangdong in coordination with Hong Kong, strengthen “hard connections” of infrastructure and “soft connections” of institutional rules, accelerate the integration of the Greater Bay Area market, and deepen industrial and technological cooperation.

Zheng Yanxiong responded that the Liaison Office will continue to be a “supra-liaison officer” and “supra-service officer,” vigorously promoting the construction of the Guangdong-Hong Kong-Macao Greater Bay Area.

Political commentator Ji Da told overseas Chinese-language outlet The Epoch Times that the international divestment from China has a huge impact on Hong Kong.

“Now Hong Kong is forced to mainlandize. The impact of international society’s divestment on the Hong Kong economy is further shocking. Currently, the Hong Kong economy has no way out. [Former Chief Executive] Carrie Lam, Zheng Yanxiong, and others keep running to the mainland, embracing the Chinese Communist Party, but in the current situation where even China’s own economy is difficult to sustain, what can they rely on?” she said.

Accelerating divestment

Global funds are accelerating the sale of Chinese stocks, with China’s economy itself facing challenges. Analysts from Morgan Stanley stated earlier this month that global long funds sold Chinese stocks at the fastest pace since December, meeting redemption requirements and distancing themselves from the world’s second-largest economy in 2023.

In a report released to clients on Jan. 2, Morgan Stanley’s quantitative research team stated that last month, a total of $3.8 billion flowed out of the active global long funds invested in the Chinese and Hong Kong stock markets, with $2 billion attributed to investor redemptions and the rest driven by fund managers’ overseas rebalancing.

The report stated that this was the worst month since 2023 and the third-largest monthly outflow on record. (9618.HK), AIA Group (1299.HK), and Yum China (9987.HK) faced significant sell-offs.

Analysts led by Gilbert Wong at Morgan Stanley stated, “Redemptions from equity funds and portfolio managers re-adjusting portfolios to further deepen divestment from China are the reasons for the outflow of funds.”

The report mentioned that due to geopolitical risks, weak economic recovery, and uncertainty in Chinese Communist Party policies, the Chinese mainland and Hong Kong stock markets became the worst-performing among major global indices by the end of 2023.

China’s benchmark blue-chip stock index, the Shanghai and Shenzhen 300 Index, fell by 11 percent in 2023, and the Hang Seng Index, covering many Chinese stocks, dropped by 14 percent, marking the fourth consecutive year of decline since its launch in 1969.

After hitting a record third consecutive year of decline in 2023, the Shanghai and Shenzhen 300 Index fell to its lowest level since February 2019 on Jan. 11.

Despite a series of measures by the Chinese authorities in recent months aimed at boosting the economy, analysts say these measures are not enough to restore market confidence.

Morgan Stanley stated that European fund managers are consistent with their U.S. counterparts, and they are catching up with the pace of adjusting divestment from China.