C&B Notes

Unforced Errors in China

Given an appropriately structured mandate and a suitably long-term perspective, there are no called strikes in investing. You don’t have to dance just because the music is playing.

China investing has become strikingly bipolar, with the strategies of many fund managers set by the answer to one overriding question: “Is the Communist party strong enough to resolve the economy’s chronic debt addiction?” Those who answer No see the Chinese sky falling, and tailor their investments accordingly. Those who answer Yes are free to gorge themselves on high-yielding domestic bonds and a bargain basement of Chinese bank equities. Others, though, are cloven in uncomfortable ambiguity. They see potential dire consequences from China’s debt problem, but are obliged [Cook & Bynum Note: an investor is never obliged to put clients’ capital at risk without an appropriate return, no matter how much career risk may be present] by the country’s strong presence in benchmark indices — a 27 per cent weight in the MSCI emerging markets equity index — to hold Chinese assets. For these investors, China investing is a giant game of chicken. “I see the [Chinese] sky falling but just not yet,” said Arjun Divecha, head of emerging market equities at GMO, an asset manager.  “They are sitting on a powder keg.  I think the Chinese can [manage the situation] but in the meantime all you need is a lightning bolt from somewhere to set the whole thing off.”

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