Several major Canadian pension funds have pivoted away from China.DADO RUVIC/Reuters
Jack Mageau is a policy researcher at the University of Alberta China Institute. He holds a M.Phil. in Modern Chinese Studies from the University of Oxford and lives in Taipei, Taiwan.
Kevin Yin is an economics PhD student at the University of California, Berkeley and was a Tobin Pre-Doctoral Fellow at Yale University. He holds an MA in economics from Yale and a BA from the University of Toronto.
Recently, several major Canadian pension funds pivoted away from China, marking an end to decades of bullishness toward the world’s second-largest economy.
One could be forgiven for thinking that human-rights issues, such as China’s treatment of its Uyghur minority, are guiding this new investment philosophy.
After all, leaders of top pension funds were brought to testify on this issue recently to the Special Committee on the Canada-People’s Republic of China Relationship (CACN), where one lawmaker told a pension fund executive, “Frankly, I don’t know how you sleep at night.”
All that came amid a breakdown in bilateral relations over foreign-interference allegations.
But while China’s problematic conduct is indeed part of the issue, that does not mean that pension funds are basing investment decisions on ethics or politics.
It’s still a game of numbers and returns. The exodus of Canadian funds from the Chinese market can be better explained by overexposure to China amid an environment of growing geopolitical risk.
Despite having fewer assets abroad than many other wealthy countries, Canadian investors in general own more assets in China compared with their competitors. Chinese bonds and equities as a share of Canada’s foreign asset position roughly doubled in the past decade, far outpacing other Group of Seven countries such as Japan, France or Germany.
While many rich countries increased their exposure to China following the 2008 financial crisis, Canada was at the head of the pack, proportional to its size.
But China is no longer looking like such a strong bet. Its aggression on the world stage and poor economic recovery has made concerns surrounding Canadian funds’ relative overexposure to China more salient.
Recent Chinese crackdowns on consulting and advisory firms raised unease about the attitude of the Chinese government toward foreign companies. At the same time, Western sanctions on more than 9,000 Chinese firms created regulatory risks for pension funds at home.
Most importantly, the spectre of a potential Chinese invasion of Taiwan has introduced a geopolitical crisis scenario that pension funds must price into their investment calculations. Specifically, a conflict in the Taiwan strait would trigger mass sell-offs of Chinese assets, which would likely result in strong capital controls from Beijing, leaving pension funds in the lurch.
The Chinese macroeconomic outlook is also beginning to appear cloudier. Warnings of an economic slowdown in China have been exacerbated by the country’s shaky recovery from the COVID-19 pandemic, and concerns surrounding Chinese local government debt and unstable housing market persist.
These conditions are already affecting pension funds.
The MSCI Emerging Markets Asia Index – which multiple Canadian funds use to invest in China – has delivered returns of just 1.3 per cent this year. This is notable in comparison to the 8.6-per-cent returns of the MSCI EM Asia Ex-China Index, which excludes China.
Therefore, despite recent actions, it is possible that Canadian funds have not pivoted away from China enough. Canadian pensions likely haven’t completely internalized the full danger of rising geopolitical tensions.
On average, cross-border positions on both equity and bonds fall by nearly a quarter as a result of geopolitical tensions, but British Columbia’s public pension manager, for example, has thus far only cut just over a seventh of its exposure to China. The CEO of the Canada Pension Plan has also doubled down on his funds’ China exposure.
Pension funds are also more exposed to China than a cursory glance might suggest. Reducing positions on Chinese securities alone does not account for the effect of uncertainty on businesses at home. Western firms depend on Chinese labour, consumption and investment. Thus when the foreign business climate is unstable, domestic companies become unsure of the future and tend to sell less, lay off employees and invest less in innovation.
Funds also continue to bear indirect risks through third-party mutual funds where they have far less oversight than on securities they hold directly. For example, the Ontario Teachers’ Pensions Plan and the British Columbia public pension have ended their private equity arms in China but have held on to positions in Chinese public markets and via index funds.
Public markets and index funds are more likely to contain large multinational firms and are thus more vulnerable to supply chain disruptions, exchange rate volatility and hastily erected trade barriers. All of this raises the financial incentive to divest in some form.
Canadian pension funds surely feel some moral obligation to invest ethically and responsibly. But public discourse fails to recognize the real risks posed by overexposure to the Chinese market to pension funds’ bottom lines. Funds’ fiduciary responsibility to retirees and the increasingly unattractive political and economic climate in China explains most of the recent uneasiness toward China.