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A friendly warning about your emerging market fund

20 November 2014

Though Goldman Sachs’ Andrew Wilson is relatively sanguine about China’s outlook, he warns that storms clouds are on the horizon within the world’s second largest economy.

By Alex Paget,

Senior Reporter, FE Trustnet

Investors need to be very aware of the potential dangers surrounding China’s falling property market, according to Andrew Wilson, as, although he feels the authorities can cope with the issue, if it were to plummet it could have far reaching impacts on global markets.

Experts agree that China’s phenomenal economic growth over the last decade or so has been primarily driven by large infrastructure spend and fixed asset investment. This growth has translated into very strong returns for equity investors – barring substantial falls during the 2007-2008 global financial crisis.

Performance of indices over 10yrs

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Source: FE Analytics

However, growth rates in China have begun to slow over recent years as the country’s authorities tried to shift the economy to a more consumer driven model.

This slowing growth has been a persistent headwind for investors in emerging markets over the last few years due to China’s position in global markets, though many believe that now is a good entry point into the world’s second largest economy as valuations are at depressed levels.

Though Wilson, chief executive of Goldman Sachs Asset Management EMEA and global co-head of fixed income, still believes the Chinese government can deal with the situation of slowing growth and its knock-on events, he says it is a clearly a potential danger to investors in the current environment.

“I would say it is on the horizon and in the back of our minds it is out there as a risk,” Wilson said.

“It’s not something that is front and centre for us. I think deflationary environment in Europe is something that concerns us a whole lot more than China.”

“However, it is not off the radar screen even and, though you may not see it in the press, there are some storm clouds out there on the horizon and that’s particularly in the real estate sector, so I would just keep an eye on it.”

While many investors may not necessarily have direct exposure to China within their portfolios via a country specific fund, experts say that given the size of its economy and as it is one of the world’s largest users of commodities, any negative sentiment surrounding the country is likely to be detrimental to more general emerging market equity funds.

As the graph below shows, while the MSCI China index has returned a lot less than the wider MSCI Emerging Markets index and IMA Global Emerging Markets sector over the last five years, they have been highly correlated.

Performance of indices over 5yrs

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Source: FE Analytics


Wilson is quick to point out, however, that investors shouldn’t be avoiding China or emerging market funds as a result.

Though he describes China’s slowing growth as something that should be on every investor’s radar screen, it is not his base case scenario that problems – such as its overheating property market – will get out of hand.

“Our view on China is still relatively sanguine – this year growth will be around 7.5 per cent largely because that’s what the Chinese government says it will be,” he said.

“That’s because they hold the levers. In particular, what we have seen with fixed asset investment, and particular infrastructure spending, is when the economy slows a little bit, the government comes in and builds a road, airport or a railway. There is very extensive infrastructure spend going on to maintain these growth rates.”

“We think, frankly, the central government will do an effective job at maintaining that growth rate, but at a lower rate – probably somewhere in the region of 6.5 per cent. They should be able to continue to allow that growth that to ratchet down to a level that is more sustainable.”

“There is no doubt that, at the moment, it is not sustainable as it is being boosted by that infrastructure spend and that party must come to an end.”

Much has been made in the press of the apparent over-investment by the Chinese authorities recently, with investors being constantly reminded of so-called “ghost cities” across the country.

Wilson agrees that there has been substantial amount of over-supply into the real estate market and he says that if there were to be any serious problems spilling out from China, it is likely to originate from its property market.

With that in mind, he says the steady decline in Chinese house prices over recent months is a “very worrying development”.

“Many of these properties are bought off-plan and there is leverage involved. We don’t know how much leverage is involved, we don’t know how many non-performing loans are out there, but this fall in house prices is pretty concerning for us,” he said.

“Now, the government has a tonne of resources at its disposal so can carry on doing infrastructure spending, building more apartments and so on, but sooner or later that story has to come to an end.”

“We are still confident that they can allow that growth rate to go down to something that is more sustainable over the next two to three years, say 5 per cent, providing there are no blow-ups.”

He added: “However the risk is that, somewhere along the way, there will be a bank, insurance company or some financial organisation getting into difficulties which could cause this house of cards to collapse.”

There are a number of experts who have far more bearish views on the Chinese economy than Wilson, of course.

In a FE Trustnet article earlier this year, Cantor Fitzgerald’s Charles Tan said he had sold his central London flat and sent his savings back to his parents in Singapore in preparation for a full-on global financial crash as a result of China’s property market.

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